BEYOND CANDLESTICKS
+Ef,Ei[EAL,
"Itarning is
a a a a a
Like Rowing Upstream;Not to Adaanceis to Fall Back"
a a o o a a a a a a a a a a a a a a a a a a a a a
a a a a a
BEYOND
CANDLESTICKS
New |apaneseCharting Techniques
Revealed
STEVENISON
IOHN WILEY & SONS, INC.
New York o Toronto
o Chichester o Brisbane . Singapore
WILEY FINANCE EDITIONS
The New Technical Trader / Chande and Kroll
Trading on the Edge / Deboeck
ForecastingFinancial and Economic Cycles / Niemira and Klein
Trader Vic II / Sperandeo
Genetic Algorithms and Investment Strategies / Bauer
Understanding Swaps / Marshall
Fractal Market Analysis / Peters
Trading Applications of ]apaneseCandlestick Charting / Wagner and
Matheny
Fixed-Income Arbitrage / Wong
Trading for a Living / Elder
The Day Trader's Manual / Eng
The Mathematics of Money Management / Vince
Intermarket Technical Analysis / Murphy
The Foreign Exchange and Money Markets Guide / Walmsley
Chaos and Order in the Financial Markets / Peters
Portfolio Management Formulas / Vince
Financial Statement Analysis / Fridson
Money Management Strategies for Futures Traders / Balsara
Dynamic Asset Allocation / Hammer
Relative Dividend Yield / Spare
Inside the Financial Futures Markets, 3rd Edition / Powers and
Castelino
Option Market Making / Baird
Fixed-Income Synthetic Assets / Beaumont
Selling Short / Walker
The New Technology of Financial Management / Chorafas
Managed Futures in the Institutional Portfolio / Epstein
Analyzing and Forecasting Futures Prices / Herbst
ForecastingFinancial Markets / Plummer
A Complete Guide to Convertible Securities Worldwide I ZubLake
Corporate Financial Risk Management / Wunnicke and Wilson
Investing in Intangible Assets / Parr
Treasury Operations and the Foreign Exchange Challenge / Chorafas
Trading and Investing in Bond Options / Wong
ACKNOWLEDGMENTS
a a a o a a a a a a a a
=
a o r
a a a a a a a a a a a a a a a
a a a a a
a a o a a a a a a a
6NHTff.A MH
"You CnnnotClap With One Hand"
A J"p"r,"se book that I had translated said that: "|apanese charts are
frequently considered secretive. The number of people who know the
essentialsof these charts are few and reference material is scarce."l This
paucity of material was particularly true with some of the new techniques
revealed in the second part of this book. However, thanks to the help of
some important individuals, I was able to uncover many previously hidden aspectsof fapanese technical analysis.
Without the assistanceof the translating done by Richard Solberg, it
would have been almost impossible to write this book-or my first one!
Not only did Richard ably do the translating, but equally important was
his tenacity in finding and obtaining the japanese books I needed for my
basic research. Richard has been one of my most vital resources.
As with my first book, I had the help of knowledgeable fapanese
traders who helped refine my knowledge by sharing valuable insights
obtained from their years of experience.
Mr. Hiroshi Okamoto, Director at Nomura Investment Trust, Mr. Yasuhi Hayashi, Senior Trader at Sumitomo Life Insurance, Mr. Nori Hayashi, Investment Manager at Barclays Trust, and other members from
the Nippon Technical Analysts Association (NTAA) in |apan were all very
gracious. I am sure many of my questions may have seemed very rudimentary to them, but they were patient and open about sharing their
knowledge. Without their insights, this book would be much less detailed.
Mr. Kiyohiko Yoshizawa, vice president at Paine Webber, provided
vu
vlll
Acknniedgments
valuable new facts and insights about the candles during our numerous
meetings.
One of my most important contactswas Mr. Yoji Inata, a correspondent for Reuters. Mr. Inata's assistancewas critical f<lr the new tools
addressedin this book; we spent many hours together. Not only did he
take his valuable time to review some of the new techniques to make
sure I correctly understood the ideas, but he also took the extra step of
conferring with his ]apanesecolleagueson points about which he was
not 100o/o
sure. Mr. Inata said that he enjoyed our studying together. I
think he was being polite. Although I may have contributed to his knowledgein somerespects,for the most part I was the student. I was fortunate
to have had a gracious, knowledgeable, and friendly teacher.
Thanks again goes to my friend, Bruce Kamich. A true professional,
he continues to provide me with a stream of insightful and helpful ideas.
The editor of this book, Susan Barry, was also the editor of my first
book. Susan had the foresight to see how brightly the interest in the
candleswould burn. She was a major factor in my choice of ]ohn Wiley
& Sons to publish this book. I hope Susan does not decide to move to a
publishing firm in the Antarctic. If I ever do a third book, I would have
to follow her.
As an English poet said: "Where ignoranceis bliss, wisdom is folly."
Before writing my first book, I was blissfully ignorant of all the time and
effort that goes into such a project. That book, made me aware of how
difficult the processis. Becauseof this, I had no desire to go through it
all again. However, Dodge Dorland, Chief Investment Officer of Landor
Investment Management (New York, NY), gave me the push to do this
second book. Dodge uses candles to trade stocks on an intra-day basis
and has been one of the earliestproponents of candles.Anyone who has
dealt with Dodge can vouch for his amiability and for his knowledge.
Many of the charts in this book are from the MetaStock software by
EQUIS International (Salt Lake City, UT). Without their assistancein
providing me with the new software to draw the kagi, three-line break,
and renko charts, this book would be much less detailed. Their excellent
software, and helpful and knowledgeable staff makes MetaStock a pleasure to use. For those interested in finding out more about the MetaStock
software, there is a coupon included at the back of this book. The data
used for the Metastockcharts was from Dial-Data (Brooklyn, NY). I found
their data accurateand easily accessible.
I would like to thank Shahrokh Nikkhah whose early appreciation of
my work and desire to make available the many advantagesof candlestick
analysis to his clients brought about my joining his team where we offer
advisory and brokerage servicesat Daiwa Securities America. I would
also thank my colleague, Mark Tunkel for taking the time to help proof-
Acknowledgments
read this book.
In this, as in my first book, you will seemany CQG charts (Glenwood
Springs, CO). They are a real-time graphics charting service. CQG was
among the first servicesin the West to offer candle charts to their clients.
I have used their servicefor many years. The accuracyof their data and
their support personnel, such as Steve Onstad in New York, make this
a premier real-time charting service. Their excellent worldwide reputation
is well justified.
Reuters Ltd. (New York, London, and Tokyo) have also provided
charts for this project. Their RTA technical analysis real-time charting
product offers some unique capabilities. I have had the pleasure of giving
a seriesof seminars for them throughout Europe. The fact that Reuters
has gone through the time, effort, and expenseto send me to Europe for
these seminars shows how committed they are in meeting the educational
needs of their clients.
My first book, lapaneseCandlestickCharting Techniques,was written
around the sametime as the birth of my son, Evan. (At the time of Evan's
bkth, I frightened my wife, Bonnie, when I said I was going to name
him "Candlesticks Nison.") Evan is now four, and he enjoys "typing"
on my keyboard. I tell you this so that if there are typos, I now have an
excuse.My daughter, Rebecca,is eight and very bright. I have jokingly
said that I wanted this book easy enough for a child to understand, so I
think I'll ask her to proofread these pages (yet another excuseif you find
any mistakes!).Finally, there is my loving and patient wife, Bonnie, who
understands that it is great to have written, but most difficult to write.
Final thanks go to those who provided another incentive for writing
this book-the credit card companiesand the bank that has my mortgage.
Note
loyama, Kenji, p.51.
ix
CONTENTS
PART ONE: CANDLES
INTRODUCTION
Chapter 1
ovERvIEw
Chapter 2
rHE BAsrcs
13
History of the candle charts, L3
Evolution of the candle charts, L6
Construction of the candle line, L8
Real body and shadows, 20
The real body,20
Long white real bodies, 20
Long white at a low price level, 2L
Long white candle confirms support, 2L
Long white body breaks resistance,23
Long white real bodies as suPPort, 25
Long black real body at high price area,29
Long black confirms resistance,30
Long black breaks support, 31
Long black as resistance,33
Size and frequency of real bodies, 35
Opening compared to prior real body, 38
Spinning tops, 40
xl
Contents
Accumulation and distribution, 42
D o j i ,4 5
Shadows,50
High-wave candles, 52
a
Chapter J
THE PATTERNS
55
Single candle lines, 56
The hammer, 56
The hanging man, 59
The shooting star, 64
Dual candle lines, 68
Dark cloud cover, 58
The piercing pattern, 73
The engulfing patterns, 76
Last engulfing patterns, 84
Harami, 86
The window, 93
Three windows, 102
Two black gapping candles, 105
Gapping doji, 106
Three or more candle lines, 109
The evening star, L09
The morning star, LL7
Record sessions,1,21,
A
Chapter t
CANDLES AND THE OVERALL TECHNICAL PICTURE
Stops, 130
Risk/reward, L33
Trend, L37
Becoming a market chameleon, 142
Computers and candles, L44
The importance of where a candle appears, \M
The question of determining specific criteria for the pattern,
145
Placing the trade, 147
When to offset a trade, L48
129
Contents xiii
PART 2: THE DISPARITY INDEX AND NEW
PRICE CHARTS
Chapter5
INTRODUCTION
153
HOW THE IAPANESE USE MOVING AVERAGES
157
The golden and dead cross, L57
The disparity index, 159
Trading with the disparity index, 159
The divergence index, L64
Chapter6
THREE.LINE BREAK CHARTS
167
Construction of three-line break charts, L68
Trading with three-line break charts, l'74
lAlhite and black lines as buy & sell signals, 174
Three-line break charts and candle charts, 176
Three-line break charts and trend, 178
Other break charts, 181
Extra confirmation of a trend reversal, l'82
Black shoe, white and black suits, and a neck, 184
Record sessionsand three-line break charts, L86
Western patterns and three-line break charts, L87
CI
Chapter /
PRACTICESESSIONFOR THE THREE-LINEBREAK
CHART
197
RENKO CHARTS
r97
Construction of renko charts, L99
Trading techniques with renko charts, 203
PRACTICE SESSION FOR THE RENKO CHART
207
KAGI CHARTS
2!3
ar
Chapter d
Construction of kagi charts,215
Using percentagekagi charts, 2L9
xiv
Contents
Trading techniqueswith kagi charts,220
Buy on yang, sell on yin,220
Shoulders and waists, 221
Multi-level br eaks, 224
Length of yang and yin, 224
Where corrections stop within the prior kagi line, 226
Double windows, 227
Trendlines,2Sl
Tweezers, 232
Three-Buddhaand reverse three-Buddha, 233
Record sessions,235
PR,ACTICESESSION FOR THE KAGI CHART
241
CONCLUSION
247
GLOSSARY
BIBLIOGRAPHY
INDEX
275
a o o a a a a o a a a a a o a a o a o a o o o o o a a a o o o a o a o a a a o a a a
PART
CANDLES
a a a a a a o a a a a o o o a a a a a a o a a a o a a a a a a o o a o a a a o a a a
+ +@
"Let EaeryBird Sing its Own Song"
a a a a a a a a a a a a a a a a a a o a a a a a a o a o a a a a a a a a a a a a t
a
INTRODUCTION
A chart is like a map, the more information each one provides, the better
the chance of reaching your destination safely. Candle charts display a
more detailed and accurate map of the market than do bar charts. A
"It is not an exaggerationto
Japanesebook that I had translated stated,
say that candlesticks are the best in the world and a very exquisite creation for charts."l This is because,as detailed below, candle charts oPen
new avenues of analysis and offer many advantages over bar charts:
1 . Candle charts will pictorially display the supply-demand situation by
showing who is winning the battle between the bulls and the bears.
Bar charts do not.
2 . Like bar charts, candle charts will show the trend of the market, but
candle charts add another dimension of analysis by revealing the force
behind the move.
3 . Bar chart techniques can often take weeks to transmit a reversal signal.
However, candle charts will often send out clues of imminent reversals
in one to three sessions.The result is that candle charts often provide
the opportunity for more timely trades.
These are just some reasonswhy the flames of interest in candle charts
grow ever brighter. In just a few years, candle charts have joined bar
charts and point and figure charts as a basic charting technique.
Candle charts are drawn using the same data as bar charts (the open,
high, low, and close), so they send all the same signals that can be found
ot but charts. Yet, as just discussed,the candles offer many advantages
over bar charts, so using candle charts instead of bar charts is a win-win
situation. When you use bar charts you only get bar chart signals. But,
with candle charts you get all the bar chart signals, plus you gain the
Candles
unique and powerful insights provided by the candles. so, why use a
bar chart?
Becausethe ]apaneseare major players in most of the world's markets, there is strong interest in how the |apaneseuse their technicalsto
trade. Candles are the most popular form of technical analysisin |apan.
The importance of the candles for the |apanese trading community is
illustrated in the following quote from the European magazine,Euroweek.
This article quotes an English trader who works at a Japanesebank. He
states:"All the |apanesetradershere-and that's in the foreign exchange,
futures and equities markets-use the candles. It might be difficult to
work out the billions of dollars traded in London on interpretations of
these charts each day, but the number would be significant."2
Think about it: Although billions are traded every day based on the
candle chart signals, until recently we had no knowledge of how the
]apaneseviewed the market with their technicals.This is hard to believe.
Knowing the candles and their other technical tools discussed in this
book may help answer the question, "What are the |apanesegoing to do
next?."
Yearsago, I met with the head of technical analysisfor one of fapan's
largest life insurance companies (this fapanese trader wanted to meet
with me to learn how I used western technicalsto trade). IzVhenhe walked
into my office, he saw I had candle charts on my desk. In a surprised
voice, he asked: "You know about the candles?." I responded that I did.
I then asked if he used them. He told me that his company's top managementwould meet eachMonday to discussthe world markets.At these
meetings, he would bring his candle charts to offer his technical views.
Then he pointed to my candle charts and asked: "How many other
Americans know about this?." I said no one (this was before the publication of my first book). He looked relieved. I then continued, "But I
will soon have a book out about it." "So, many others will know about
this?," he asked in a disappointed tone. The point of the story is that
the Japanesetrader came to me to learn about how we, in the West, use
technicals.The fapanesehave learned from us and they know almost all
of our technical methods. In most of the candlestickbooks and articlesI
have had translated from Japaneseto English, there was at least some
referenceto western technicaltechniques.A quote from one of the books
I had translated stated, "To understand stocks it is not enough to know
the |apanesechart methods . . . one must absorbthe best parts of western
technicals:and on top of that using the best parts of Japanesecharts to
make for a progressive outlook which is necessaryfor stock analysis."3
We can seefrom this statementhow the fapanesehave used our methods
to enhancetheir own. one of the purposes of this book is to do the same
lntroduction
for Western traders-to show how to use the techniques implemented
by the Japaneseto enhance our market knowledge.
An article about my work appeared in the lapan Economiclournal. Tn
"lapan, which has been in the position to learn
it, the reporter states:
many things from the West in the investments area, may be in the position to teach something."4 We now have accessto a wealth of technical
information refined by generations to use; we afe learning from the Japanese.
Chapter 2 shows how to draw the basic candle line, and delves into
some history of the candle charts. Later in that chapter, I show how a
single candle line can provide important market insights. Chapter 3 discussesthe basic candle patterns. With the detailed descriptionsof these
patterns, those new to candlesand candleexperts can discover new market perspectives.The last chapter in this section, Chapter 4 focuses on
how the overall technical picture is more important than a single candle
pattern.
Notes
lHoshii, Kazutaka,p. L8.
zEuroweek,
August 30, 199'1.
3Yasui,Taichi, p. 95.
aThe
lapan EconomicJoumal, ldy 23, 7991
CHAPTER1
OVERVIEW
)
{ t J , t)E ( ffi
n d-
"The Buddhais Complete,But the EyesAre Not in Yet"
(Thelob is Nof Yet Done)
THE EXPLOSIVE INTEREST IN THE CANDLES
"A clever hawk hides its claws." For over
L here is a Japanesesaying,
a century, the claws of Japanesetechnical analysis, that is candlestick
charts, were a secrethidden from the western world.
is
For those new to the exciting field of candlestickcharts, candlestick
the term used for Japan's most popular and oldest form of technical
analysis.They are older than Western point and figure and bar charts.
Amazingly, candlestickcharting techniques,used for generationsin the
Far East, were virtually unknown to the West until I revealed them in
ChartingTechniques.
my first book, lapaneseCandlestick
I am pleased and proud that my first book has been credited with
revolutionizing technical analysis by igniting the flames of interest in the
candles. Before its publication, few people in the West had ever heard
of a candle chart. Now, candle charting techniquesare among the most
discussedform of technical analysis in the world!
Interest in candle charts has become so intense that the World Bank
in Washington, DC asked me to addressthem on the subject.The worldwide interest in these previously secret techniques are reflected in the
financial headlines below:
FF
TradingSystem"
AncientJapanese
lnaestor-"Revealed!
lnstitutional
Light Traders'Path"
WallStreetloumal-"lapan's Candlesticks
ChartingComesof Age"
Euroweek-"Candlestick
Candles
Equitylnternational-"Candlestick
Charting-A New Languagefor the west"
Reuters-"Candlesticks
Light New Pathfor WesternChartists,,
For over 70 years, the standard charting tools in the west have been
bar charts and point and figure charts. Yet, within a short time, candle
charts have now joined these as a basic charting tool. The rapidity with
which this has happened is a direct reflection of the candle's popularity
and value.
The groundswell of interest in the candlestickcharting has becomea
topic in the media. A TV show, TechTalk, on the business news cable
station CNBC is hosted by the famous technician, fohn Murphy. john
told me that a viewer once called and asked him, "What are those charts
that look like hot dogs?" What an interestingand amusingidea, I thought,
to Americanize these charts by referring to them as hot dog charts. But
I guess the term "candle chart," thankfully, is here to stay.
I have had many wonderful compliments from famous traders and
analysts.However, the most endearing compliment came from a woman
who wrote, "lf you ever have a down day, just remember there's a nice
little grandmother in Missouri who's in awe of your accomplishments."
This letter, besidesbeing so gracious, illustrates the universal appeal of
candles-from traders at the World Bank to a grandmother in Missouri.
The reason for the popularity of candlestick analysis is easy to understand. They can be melded with any other form of technicalanalysis,
they are applicable to any of the markets to which technical analysis is
applied, and they provide market insights not availableanywhere else.
Why this book? A renowned 16th-centurysamurai swordsman stated
that "learning is the gate, not the house. You first have to go through
the gate to get to the house."
My other book, lapaneseCandlestickCharting Techniques,took you
to the gate. This book takes you to the house and has many new, exciting, and effective techniques to improve your trading, investing, or
hedging.
Japanesecharting was considereda secret.However, I have managed
to pry open the "secrets of the Orient" by exchangingideas with many
Japanesetraderswho use candlesand by having many hundreds of pages
translatedfrom ]apaneseinto English. Lin Yutang, a noted Chinesephilosopher, sagely noted that one gets a different flavor from reading the
same book at different stagesin life. Therefore, he says, all great books
can be read with profit and pleasurea second time; I have found this to
be true.
In the time since the publication of my first book, I have reread my
original candlestick documents and have gleaned new insights. In addition, I have obtained and translated new ]apanesematerial, have ex-
Overuiew
panded my dialogue with more fapanesetechnicians and, of course, have
continued to learn from my use of candles. I reveal these new and valuable insights in this book.
My first book focused on the futures markets. The candles have now
become so important that their popularity has spilled over from futures
into stock, bond, and foreign exchange markets from around the world.
As a result, this book will have many more of the charts than did my
other book.
At times, a single candle line can be important. The Japanesehave a
saying, "With the fall of one leaf we know that autumn has come to the
world." In this sense,a single candle line may be the first sign of a market
turn. In this book, I will show how to use individual candle lines to obtain
clues about the market's health.
It has been very exciting to see the intense interest sparked by the
candles. However, it is often forgotten that the emergenceof a candle
pattern is but one aspectof trading. Other aspects,such as the risk and
reward ratio of a potential trade and monitoring where the candle pattern
appearsin the overall technical picture, must also be considered.This is
so important that I have devoted a chapter to these aspects.
In my continuing studies of ]apanese trading techniques, I have uncovered three charting methods that are very PoPular in ]apan, yet are
unknown to the West. These charting techniques are called three-line
break charts, kagi charts, and renko charts. They are revealed in Part 2
of this book.
In the days of fur trading in the United States, there was a comPany
called the Hudson Bay Trading Company. Th"y were known for taking
risks and for careful preparation. Trading journeys were undertaken with
much excitement, but in casethe fur traders forgot anything, they would
camp out the first night just a few miles away from the company's headquarters. In other words, careful preparation spared the travelers potential difficulties.
In Chapters 2 and 3, I too provide careful preparation by providing a
primer on basic candle theory and patterns. For those new to candle
charts, these chapters will provide the groundwork for your candle chart
analysis.
Many of you are probably already familiar with the basics of candle
charts. With this in mind, Chapters 2 and 3 will also offer a deeper
knowledge of the candles by revealing new candle theories, techniques,
and tools. As a result, even those knowledgeable about candles will gain
new insights and pelspectives into the power of the candle charts. For
example, when I describe the candle patterns in Chapter 3, I will provide
a unique visual glossary of candle patterns. This method of drawing the
patterns will provide a dimension of candle pattern analysis that was
10
Candles
never before available. After you explore with me the beauty and power
of the candle charts, you will never be able to go back to a bar chart.
This book will be a self-contained unit. I will not go over all the candle
patterns; that is done in my first book. However, I will sometimes make
referencesto the more obscureor rare patterns discussedin my first book.
This is for the benefit of those who are familiar with all the candle patterns. Do not worry if you have not heard of the pattern before; it will
not detract from the discussionof the chart.
Numerous charts and exhibits will quickly and clearly make evident
how candlescan enhanceyour trading, timing, and investing. As shown
throughout the book, candles can be merged with any other form of
technical analysis. Consequently, I have included charts that show how
to fully utilize the candles' power alone, or when joined with other technical tools.
Just as important as the recognition of candle patterns is an understanding of the relationship of the candle patterns to the overall technical
picture. Chapter 4 focuses on this vital, but often neglected, aspect. In
this chapter, I will addresshow trading with the candles must take into
account the risk and reward of a potential trade, the stop-out level, and
the overall trend. I will also address the value of adapting to changing
market conditions.
Before I discusstrading with candles, I want to clarify a few points.
In the futures market, selling short is as common as buying long. This is
not true in the stock markeU most equity traders look to buy. Consequently, throughout this book when I use the term "bearish" or "selling" when discussinga stock, you should not think of necessarilygoing
short. Instead, view it as an area to protect existing longs by such means
as selling covered calls, moving up protective stops, or offsetting all or
some longs.
But this book is about more than candles. In Part II I reveal the disparity index, the three-line break, renko charts, and kagi. These techniques, popular in Japan,are virtually unknown in the west and, unlike
candle charting, little has been written about these techniques, even in
Japan.
The disparity index comparesthe closeto a moving average.It is used
in the same manner as dual moving averages,but it has an interesting
wrinkle to it. The three-line break, kagi charts, and renko charts are
popular among Japanesetraders. They are excellent technical tools for
determining the trend of the market.
Whether you use the techniques discussedin this book individually
or in combination with one another, you will discover that they provide
dynamic advantagesfor those who make use of their tremendouJ potential.
11
Note to Reader: Many charts in this book, especially in Part II, were
drawn using technical analysis software from Metastock by EQUIS International (Salt Lake City, UT). A coupon for Metastock Software is
included at the end of the book.
CHAPTER2
THE BASICS
d\sdt.
"lnattentionis Fatal"
HISTORY OF THE CANDLE CHARTS
rF
I Hg fapanesewere the first to use technical analysisto trade one of the
world's first futures markets-rice futures. The Japanesestarted trading
in this market in the 1600s.Interestingly, the birth of the Japaneserice
futures market was a consequenceof the country's military history.
After a century of internal warfare among the daimyo ( Japanesefeudal lords), General Tokugawa Ieyasu, who ruled from Edo (the ancient
name of Tokyo), won the famous battle at Sekigaharain 1600.This was
the battle that helped unify fapan. Tokugawa thereafterbecameShogun
of all ]apan. After his victory over the daimyo, General Tokugawa cleverly required that all the feudal lords live in Edo with their families. When
the lords returned to their respective provinces, the entire family stayed
at Edo as hostage.The feudal lord's main sourceof income was rice that
was collectedas tax from the peasantswho worked their land. Sincethis
rice could not be transported from the daimyo's provinces all the way to
Edo, they set up warehousesin the port city of Osaka to store their rice.
Becauseall these powerful daimyo lived so closeto eachother in Edo,
they attempted to outdo one another in lavish dress,mansions,and other
"The Edoite
luxuries. This was reflectedby a popular saying at the time,
will not keep his earnings overnight." This showed that the daimyo in
Edo were seen as spendthrifts with an expensive lifestyle. To maintain
this lifestyle, the daimyo sold rice from their warehouse in Osaka; sometimes thev even sold rice from future harvests. The warehouse would
13
t4
Candles
issue receiptsfor this future rice. These were called empty rice contracts
("empty tice" since the rice was not in anyone's physical possession)
and they were sold in the secondarymarket. This was the beginning of
one of the world's first futures market.
Trading in rice futures engenderedmuch speculation,and it was from
this speculationthat Japanesetechnical analysiswas born. The most famous trader in the rice futures market was Homma. Homma traded in
the rice futures markets in the 1700s.He discoveredthat although there
was a link between the supply and demand of rice, the markets were
also strongly influenced by the emotions of the traders. Becauseof this,
there were times when the market perceived a harvest as different from
the actual. He reasonedthat studying the emotions of the market could
help in predicting prices. In other words, he understood that there was
a differencebetween the value and the price of rice. This differencebetween price and value is as valid today with stocks, bonds, and currencies, as it was with rice centuries ago.
In the material I had translated, candle charts are often called Sakata
charts in referenceto the port city of Sakata,where Homma lived. However, basedon my research,it is unlikely that Homma used candlecharts.
As will be seen later, when I discussthe evolution of the candle charts,
it was more likely that candle charts were developed in the early part of
the Meiji period in japan (in the late 1800s).
whether or not Homma invented charting is open to question. But
determining whether one person, in this caseHomma, createdcharts or
used them to trade is not too important. There is a tendency in the West
to be preoccupied with imposing authorship to one person. It is more
likely that the candle charts we know today and all the techniques associatedwith them tended to be a processof cumulative authorship by
severalpeople over many generations.Even if he did not invent candle
charts, Homma understood that the psychologicalaspect of the market
was critical to his trading success.And it appearsthat the earliestforms
of technical analysis in Japan dealt more with the psychology of the
market rather than charts.
In the book, The Fountainof GoId-The ThreeMonkeyRecordof Money,
purportedly written by Homma, the author states: " After 60 years of
working day and night I have gradually acquired a deep understanding
of the movements of the rice market." The book then goes on to say:
"when all are
bearish, there is cause for prices to rise. when everyone
is bullish there is causefor the price to fall." This phrase echos what is
now called contrarian opinion, a tool important to so many traders. yet,
The Fountainof Gold-The ThreeMonkey Recordof Money, was written in
1755.It is amazing that before America was a nation, the Japanesewere
trading with contrarian opinion! The title had me perplexed for some
The Basics
"three monkeys" in the
time. I did not understand the reference to the
title. Then in some of my translated material, it said something about
comparing successfultrading to being like the three monkeys we all knew
as children-see, hear, and speak no evil. Then it dawned on me; the
title of the book, The Fountainof Gold-The ThreeMonkeyRecordof Money,
"fountains of gold," they should
means that for traders to get to their
have the characteristicsof these three monkeys. Specifically:
L. "See no evil"-when yolJ seea bullish (bearish) trend, do not get
caught up in iU consider it an opportunity to sell (buy).
In the Fountain of Gold, it states that there is always a rotation of Yang
(bullishness) and Yin (bearishness). This means that within each bull
market, there is a bear market, and within a bear market, there is a bull
market. This view may explain why fapanesecandlestick techniquesplace
so much emphasis on reversal, rather than continuation, patterns.
2. "Hear no evil"-when
on it.
vou hearbullish or bearish news, don't trade
It may be safer to take a position after you determine how the market
reacts to a news item rather than initiating a trade when the news is
released. Bernard Baruch, the millionaire stock speculator and presiden"are not
tial advisor, stated that what is important in market fluctuations
the events themselves, but the human reactions to these events." Exhibit
2.L shows that how the market reactsto the news may be just as important as the news itself.
The Iraqi War started in the first few days of August 1990.Yet, Exhibit
2.L shows that gold stalled at$425.This $425levelwas gold's high earlier
in 1990. This failure to take out the prior high was in spite of the fact
that there was a Mideast War. Gold's failure to rally on suPPosedly
bullish news sent out volumes of information about the state of the market. To wit, be careful of a market that fails to rally on bullish news. Note
that after this failure at$425, gold lost its luster as prices returned to their
pre-Mideast crisis price near $360 within two months.
"whispering tactics."
Also be aware of what the Japaneserefer to as
This is what they call the spreading of false news to trick others in the
market. Try to keep out of rumor buffeted markets. Isaac Newton once
said, "I can calculate the motion of heavenly bodies but not the madness
of people." Why get involved with the madnessof people?
3. "Speak no evil"-don't
do in the market.
speakto others about what you are going to
15
16
Candles
EXHIBIT 2.1. Observing the Market's Reactionto FundamentalNews, GoldDecember 1990,Daily
Has the following happened to you? Basedon your analysis,you decide
to buy into a market. You tell someone else of this decision, but they say
something negative about that market. Becausethere is always a degree
of uncertainty, you get nervous and decide not to buy. Then, of course,
the market rallies.
If you have carefully studied the market, it is safer not to speak to
anyone about what you plan on doing unless you believethey have better
insight than you. Look only to the market to give you direction. In one
of my favorite passagesinThe Fountainof Gold, it says that ". . . to learn
about the market ask the market-only then can you become a di:testable
market demon." Isn't that a wonderful phrase? Wouldn't you love to
becomea detestable
marketdemon?The colorful languageused by the Japaneseis just one reason their technical techniquesare so exciting.
Let us turn our attention to Exhibit 2.2, which illustrates the path that
ultimately led to the candle charts.
Evolution of the Candle Charts
A. Stopping chart-Also referred to as a point, line, or star chart. This
was the earliest type of chart and was drawn by joining only closing
The Basics
17
(A)
StoppingCharts(close)
/,4.v J .f+
t
(B)
PoleCharts(High-Low)
:tr
(D)
AnchorChart(High-Low-Close-Open)
(c)
Bar Chart (High-Low-Close)
tf', fi
,f
(E)
CandleChart(High-Low-Close-Open)
+ { ' {+ t ".,iTt:l' i l t T
H
o*
'4
H
EXHIBIT 2.2. The Evolutionary
Path to the Candlestick Charts
prices. Th"y were named stopping charts becausethat was where the
prices stopped by the end of the session. Stopping charts were drawn
with either diagonal lines or horizontal lines connecting the closes.
B. Pole chart-Its name is derived from the fact that the lines resemble
poles. This chart added the extra information imparted by showing the
range between the high and the low of the session.Theselines show not
only the direction of the move, but the extent of the move for each
session.
C. Bar chart-This is a combination of the stopping and pole charts.
D. Anchor chart-Named as such because it looks like an anchor.
Based on legend, these charts originated in the Kyoho Era (from 1716)
from the fact that the usual meeting place for rice traders was port cities.
The anchor chart was an important event in the evolution of charting.
With this chart, the opening price was now added and created a chart
with an open, high, low, and close. Just as important, and something
unique to fapanesecharts, was that the relationship between the open
and closewas pictorially displayed. The top and bottom of the anchor's
vertical line are the high and low of that session.The horizontal line of
the anchor line is the open. The arrow of the anchor line is the close. If
the close is higher than the open, the arrow points up; if the close is
lower, the arrow points down.
18
C-andles
E. Candle chart-The next improvement from the anchor charts was
the candle chart. Although they are shrouded in mystery, the candles
probably started in the early part of the Meiji period (from 1868).As can
be seen in Exhibit 2.28, candle lines were a refinement of the anchor
chart. The use of black and white real bodies made analyzing the underlying supply and demand situation visually easier to determine than
with the anchor charts.
With the arrival of the candle charts, Japanesetechnical analysis flowered as people started thinking in terms of signals and trading strategies.
Patterns were developed and market prediction became more important.
Trying to forecast the market took on extra importance in the L870swhen
the fapanese stock market opened.
As can be seen from Exhibit 2.2, bar charts were one of the ancestors
of the more evolved and productive candle charts. In essence,this means
that since most of the West is still using bar charts, it is also using a less
evolved form of charting than the Japaneseare with candle charts.
CONSTRUCTION OF THE CANDLE LINE
The first step in using the power of candles is learning how to construct
the basic candle line. Exhibits 2.3. and 2.4 show that the candle line
consists of a rectangular section and two thin lines above or below this
section. We see why these are named candlestick charts; the individual
lines often look like candles with their wicks. The rectangular part of the
candlestick line is called the real body. lt represents the range between
the session'sopen and close.When the real body is black (e.g., filled in),
it shows that the closeof the sessionwas lower than the open. If the real
body is white (that is, empty), it means the close was higher than the
oPen.
White Real Body
Black Real Body
EXHIBIT 2.3. White Real Bodv
EXHIBIT 2.4. Black Real Body
I
F.-==*
The Basics
The thin lines above and below the real body are the shadows.The
shadows represent the session'sprice eXtremes.The shadow above the
real body is referred to as the upper shadow and the shadow under the
real body is the lower shadow. Accordingly, the peak of the upper shadow
is the high of the sessionand the bottom of the lower shadow is the low
of the session.
Candle charts can be used throughout the trading spectrum, from
daily, to weekly, and intra-day charting. For a daily chart, one would use
the open, high, low, and close of the session. For a weekly chart, the
candle would be composedof Monday's open, then the high and low of
the week, and Friday's close.On an intra-day basis,it would be the open,
high, low, and close for the chosen time period (i.e., hourly).
Exhibit 2.3 shows a strong sessionin which the market opened near
the low and closed near its high. We know that the close is higher than
the open becauseof the white real body. Exhibit 2.4 illustrates a long
black candlestick.This is a bearish sessionin which the market opened
near its high and closed near its low.
The |apanesefocus on the relationship between the open and close.
This makes sense;probably the two most important prices of the day are
the open and close. It is therefore surprising that American newspapers
have openings for futures prices, but not for stocks. A member of the
Nippon TechnicalAnalysts Associationtold me that he found it unusual
that U.S. newspapers do not have opening stock prices; the Japanese
have the openings in their papers. He said that he did not know why
the Americans disregard the openings.
I would expect that just as almost all technical software vendors now
carry candle charts, so it may be that as candles become more popular
in the equity market, newspapers may, by popular request, carry stock
openings. Until then, in order to obtain the data needed to draw the
candles (the open, high, low, and close)you need to use a data vendor
service.These servicesfurnish prices on disks or through modems. The
data supplied from a data vendor are then transferred into a technical
analysis software package that will draw the candles based on these
data.
A note of caution: Some data vendors who do not have the actual
opening price of a stock default to the prior session's close as today's
open. This, in my opinion, is not valid. You must have the true open to
draw an accuratecandle line. Although an open on a stock will usually
not be much different from the prior close, there are some candle patterns
in which a higher or lower opening (compared to the prior close) gives
valuableinformation. A data vendor that includes actual opens on stocks
is Dial Data (Brooklyn, NY).
t9
20
REAL BODY AND SHADOWS
While an individual candle usually should not be used alone to place a
trade, the size and color of its real body and the length of its shadows
can provide a wealth of information. Specifically,looking at a line's real
body and shadows gives a sense of the supply and demand situation.
This section will discuss this basic idea, and explain how to use real
bodies and shadows to get clues about the market's underlying strength
or weakness.By using the candle lines discussedbelow, you may be able
to get an early and tentative indication of market direction.
THE REAL BODY
In ]apanese charts, even an individual candle line has meaning, and one
of the first clues about the vitality of the market is to look at the size and
color of the real body. To the |apanese, the real body is the essenceof
the price movement. This is a critical and powerful aspectof candle charts;
through the height and color of the real body, candle charts clearly and
quickly display the relative posture of the bulls and the bears.
This section will be segmented according to the decreasingsize of the
real bodies. The first part of this section will consequently focus on long
white and then long black real bodies. After these, attention is turned to
candles with small real bodies called spinning tops. These diminutive
real bodies display a market where the bulls and bears are in a tug of
war.
This section will conclude with candles that have no real bodies. These
candles have the same (or nearly the same) opening and closing. Such
candles, called doji (pronounced d6-gee), reflect a market in a state of
transition. Doji, as you will see later, can be an important market signal.
Long White Real Bodies
A long white real body is defined as a session that opens at or near the
low of session,and then closesat or near the session'shigh. The close
should be much higher than the open. For example, if a stock opens at
$40 and closes at $4ff/v it would not be a long white candle since the
opening and closing range were relatively close. For a long white candle
to have meaning, some Japanesecandlestick traders believe that the real
body should be at least three times as long as the previous day's real
body.
The Basics
, I
I
I
t ,
tl
'il"",'
EXHIBIT 2.5. Long White at a Low Price Level
Long White at a Low Price Level
A single candle by itself is rarely sufficient reason to forecast an immediate reversal. It could, however, be one clue that the prior trend may
be changing. For instance, as shown in Exhibit 2.5, a long white real
body at a low price range may be the first sign of a market bottom. A
long white candle shows that the ability to rise is virtually unimpeded
by the bears. The closer the close is to the high of the session,and the
longer the white real body, the more important the candle line.
Exhibit 2.6 shows that in late \991.,this stock was stabilizing near $5.
The first sign that the bulls were attempting to take control was the
unusually long white real body at 1. Note how this real body was extended compared to the prior real bodies. However, an almost equally
long, but black real body (for information on black real bodies, seepage
29), on the week after candle L showed that the bears still had enough
force to offset the bulls' advance. In early \992, another unusually long
white candle, shown at2, appeared.This white candle opened on its low
(since it does not have a lower shadow) and closed on its high (since it
does not have an upper shadow). Such a candle is exceptionallystrong,
notably when it is so elongated as in candle 2. Candle 3 was another
strong white candle that propelled prices to new multi-month highs. With
the tall white candles L and 2 both appearing near $5, we can see the
significanceof that $5 support area. Consequently,when prices corrected
back to this level in fuly and August 1992, it is not surprising that the
selloff stopped near $5.
Long White Candle Confirms Support
As shown in Exhibit 2.7, the tall white candle that rebounds from support
underscoresthe aggressivenessof the bulls. A long white candle that
bouncesoff a support area such as a trendline, a moving average,or a.
retracement level gives extra confirmation of that support.
21
22
Candles
AURORAELECTRIC- WEEKLY
I6. U
15.0
t5.5
15.5
t5.0
14.5
t4.0
t3.5
13.0
12.5
L2.O
11.5
I1.0
t0.5
10.0
9.5
9.0
8.5
t-5.
t4.5
14.0
13.5
13.0
12.5
L2.O
tt.5
tt.0
.il
U.U
7 q
7.O
b.5
b.u
5.0
4.5
6 n
4.5
'9?
rLE
IlAY JUN JUL
0cT NOU
MetaStockby EQUTSInt'l
EXHIBIT 2.6. Long white Candle at Low price, Aurora Electric-weekly
I
t l
"'I
Movingaverage
Priorlows
as support
2.7.
10.0
9.5
s.0
8.5
8.0
7.5
7.O
5.5
5.0
5.5
u,[,1i"-r+,0[|u*'*"**'?*'rolro*'**ru+n
'91
DGIIBIT
i-u.5
Long White Candle Confirms Support
'93 TLH
23
The Basics
GENLRE_ DAILY
130
123
130
L29
128
L?7
L?6
L25
L24
L23
122
,ilr,
,il[|il+'
i-o
L1A
127
L26
LZ5
L?4
LZ3
'
*l*,.,ofo,,
il*t,
oo,[o,oo
122
L?I
120
I 15
118
LL7
i-rb
LL4
113
LLz
111
LL0
109
108
LO7
'92
LZL
120
119
118
TL7
lt6
tt5
114
lt?
LLz
1tl
110
t0s
108
102
z3
14
,93
t1
l8
OB
MetaStockby EQUIS Int'l
EXHIBIT 2.8. Long White Candle Confirms Support, General Re-Daily
In Exhibit 2.8, we seehow drawing a support line with a candle chart
is done the same way as with a bar chart. In this case,we are looking at
a support line that is obtained by connectingthe lows of the session(that
is, by connectingthe bottom of the lower shadows).This upward sloping
trendline was tested numerous times. In late January,a bounce from this
support via a long white real body showed the eagernessof the bulls to
buy near that support.
Long White Body Breaks Resistance
Exhibit 2.9 displays how the market can prove its mettle by piercing a
resistancearea with a tall white real body. As shown in Exhibit 2.10, the
highs at areasA and B disclosed a resistancearea near $44 and $45. In
late November, an extendedwhite real body gapped higher on the oPen-
24
Candles
EXHIBIT 2.9. Long White Candle BreaksResistance
ing and closed at the session'shigh. This tall white candle confirmed an
important breakout from the aforementionedresistanceband. Note how
in early 1993the gap before this white candle became a support area. we
will look at the importance of gaps as support when windows are discussedin the next chapter.
BANK AMERICA- DAILY
56.5
56.0
56.5
56.0
s.5
s.0
55.5
55.0
54.5
54.0
53.5
53.0
52.5
52.O
5 t. 5
51.0
54.5
54.0
53.5
53.0
52.5
52.0
51.5
5t.0
fl'1,p
s).5
s).0
49.5
.19.0
48.5
.18.0
47.5
47.9
46.5
46.O
.15.5
45.0
44.5
11.O
43.5
43.0
42.5
42.O
41.5
.tl.0
F N F
,il'
,q'1,,*lrl-,fl,,oo
,,,il,,*o'*ot'lnf
h-***
','1,0-*-,$ro-l*oLlS
t.
l-il
+_gap
ry*t
I
.1u.5
'9.
50.0
49.5
43.0
48.5
48.0
47.5
17.O
46.5
46.O
45.5
45.0
14.5
44.8
43.5
43.0
42.5
42.O
41.5
4 1 .0
40.5
L2
19
26
n
a7
L4
,93
It
[ts
The Basics
25
Long White Real Bodies as Support
Exhibit 2.11 brings out one of the more exciting uses of long white candles, specifically, that long white candles can become support areas. I
have found this to be an excellent tool since it serves to alert traders to
support zones that are not available with bar charts. The depth of the
reaction should find support at either the middle of the long white real
body or the bottom of the entire white candle, including the lower
shadow. The Japaneseliterature says that a long white real body should
be support in a rising market. However, based on my experience,it can
also be used as support in a falling market. The reason the market may
fall back after an exceptionally tall white real body is that prices may
become short-term overbought (that is, they rallied too far too fast). In
this scenario, the market may have to retrace some of the prior rally to
relieve this overbought condition.
In Exhibit 2.12, the huge white candle in early 1992 propelled prices
from $1012to about $15. Almost a 50o/orise in one week! After such a
move, it was not surprising that the market had to consolidate its gains.
Basedon the precept that a long white candle is support, the middle of
should then be monitored
the white real body (at the arrow), near $121/2,
as support. The power of the market is well reflected by the fact that for
the rest of 1992,the market held above this support area.
r l ' l r
(1) 50o/"within
long white
real body
Support
1,1
l 1 l
(2) Bottom of long
white candle's
lower shadow
Support
EXHIBIT 2.11. Long White Real Bodies as
Support
26
Candles
- WEEKLY
CITICORP
n
2g
27
25
25
24
23
22
2L
20
l9
18
L7
16
15
14
l3
LZ.
27
26
z3
24
z3
22
2L
20
l9
f'o''f,,,,,-,+n{il{
il,1+,,lillttlft*,,
,,,*,,nililfil
ts
L7
*ilf*l**or*il+**,r*l-l
*pnfrntryil
ll**--
lb
l5
14
t3
L2
1l
10
il.
10
J
B
I
7
7
'gl
J
R
S
O
N
t] ,92
F
t1 A
II
J
J
A
S
B
N D
,93
EXHIBIT 2.12. The Middle of a Long l4lhite Candle as support, Citicorp-weekly
Exhibit 2.13 illustrates how the lower end of tall white bodies L-4
became support on corrections. Of interest is that the support line obtained by extending the low of candle 3 was broken in September 1992.
Observe, however, that the sell-off stopped near the support area from
the low of candle 2. This chart also illustratesan important point. Candlestick traders should wait, if possible, for the market to close under support to confirm a break. In this example, we see in mid-1992 that the
support level from the bottom of candle 3 was broken intra-weekly (see
X on the chart), as was the support by the bottom of candle 4 (see Y).
Becausethe weekll (i.e., the Friday) closeheld abovethesesupport areas,
the support line was still in force.
Notice in Exhibit 2.14how the low of the long white real body in early
April (at the arrow) was 109-22. This means that area should provide a
base on sell-offs. In this exhibit we see the importilrce of waiting for a
close under a support area to confirm the breaking of support.
The Basics
EXHIBIT 2.L3. Bottom of Tall White as Support, Dow fones-Weekly
EXHIBIT 2.14. Bottom of Tall White Candle as Support with Bond Futures-D6ily
28
Candles
A method you could use with this concept of tall white candles as
support is to buy on a correction near the midpoint of the white candle.
From that level down to the bottom of the long white candle (this includes
the bottom of the lower shadow) should be support. If the bottom end
of the support zone (that is, the lows of the tallwhite candle) is penetrated on a close, then you should reconsider your long position. et
times, these support areas are broken on an intra-sessionbasis, but as
long as the support holds on the close, I still view it as valid support.
one of our institutional clients told me he found that, at times, after
a tall white candle, the market corrects.I advised him that such action is
not surprising since after such a candle, the market may be overbought
and hence vulnerable to a setback. I then suggestedthe use of a long
while candle as a support area in which he courd buy on a correction.
Coincidentally, on November 23, at the time the trader and I were talking
about this, the bond's first hour of trading had just ended. This first
hour, as shown in area 2 in Exhibit 2.1s, completed a tall white candle.
since he traded bonds, I informed the client that support should be from
the halfway point of this white candle down to the bottom of the candle,
including the lower shadow. I then pointed out that there was another
long while candle from the preceding day's first hour of trading (see
using the support Zone in a Tall white Candle December 1993Bond
The Basics
candle 1). The bottom of that tall white candle (including the shadow)
was successfullydefended as suPport with candle 2. Thus, there were
two white candles (at L and 2) that reinforced the support near \14-16.
Note how, after white real body 2, the market retraced about halfway
into it before rallying.
Long Black Real Body at High Price Area
just as a long white candle could be an early signal that the market may
be trying to build a bottom, so it is that a distinctively long black real
body at a high price may be a tentative warning of a top. The long black
real body should be significantly longer than the candles preceding it.
This is illustrated in Exhibit 2.16. Such a long black real body displays
that the bears had grabbed control of the market. The longer the rally
continued and the more overbought the market, the more reliable the
cautionary signal of this long black real body becomes.
The long white candle (1) in Exhibit 2.17 echoes a vibrant market.
However, there were a few warnings that Home Depot was overheating.
The first was that the relative strength index (RSI) was above 70o/o.Such
a high RSI figure is a clue that the market is overbought. Another sign
that the bulls were losing their upside push was the series of small real
bodies following the tall white candle at 1. These small real bodies showed
that the supply-demand situation was more in balance as comPared to
tall white candle 1 (candle L showed that demand was overwhelming
supply). Small real bodies are discussedin more detail later in this chapter.
Falling black real body at 2 showed that the bearshad wrested control
of this stock. Note how black real body 2 was the longest black real body
since at least November 1992. This shouts out a warning that there is
now something very different about the market, and that appropriate
defensiveaction-such as selling coveredcalls, or offsetting some longsshould be undertaken. For those who are familiar with all the candle
patterns, note how the tall white candle at 1 and the black real body at
'' , ,
rl
r'l
EXHIBIT 2.16. Long Black Real Body at High Price Area
./\
29
30
Candles
HOMEDEPOT
& 14 PERIOD
RSI
75
IU
5t
50
19
18
17
16
{5
11
13
12
4L
51
50
19
18
17
16
15
11
13
12
1t
{0
4n
tu
'3223 0 07 r1 21
28,$ ir l8 t5
EXHIBIT 2.17. Large Black Candle at High Price and the Relative
Strength Index,
Home Depot-Daily
2 formed a bearish tower top, so named becausethe two long candlesat
1 and 2look like towers.
Long Black Confirms Resistance
If, as shown in Exhibit 2.j.8, the market backsoff sharply from resistance
through a long black candle, it is extra confirmation of the resistance
area. This is because such a candle means that either the bulls have
Priorhighs as
resistance
EXHIBIT 2.18. Long
BlackCandle Confirms
Resistance
The Basics
EXHIBIT 2.L9. Long Black Candle at Resistance,Cash Yen-Weekly
retreatedor that the bearshave becomeaggressiveenough to overwhelm
the bulls. Either of these scenariosis potentially bearish. In Exhibit 2.19,
there is an evident resistancearea near 135 yen. This is shown by the
horizontal trendline. The first long black candle at the arrow stalled at
this resistance.With the retreat from this resistancethrough this unusually long black real body, there was a causefor caution. Two weeks
later, the second, even longer black real body signified the capacity of
the bears to drag prices lower.
Long Black Breaks Support
As shown in Exhibit 2.20, the way the market breaks a support areamay
indicate the seriousnessof the break. For instance, a move under a suPport areaby way of a long black candle should be viewed as a potentially
more bearish scenariothan if the market closesunder a support areawith
a short black candle or a white candle.
A popular longer term moving averagemonitored by both Japanese
and American stock market participants is the 200 day moving average.
Exhibit 2.21-shows how this moving average was support throughout
31
32
Candles
l l r
l , ' , t l ' ,
EXHIBIT 2.20. Long Black Candle BreaksSupport
late 1992 into January 1993. However, the first sign of a break of this
support cameby way of long black real body 1. Although this only broke
the 200 day moving average line by a few cents, it was an early, but
provisional, sign of trouble. Final proof of a decisive break of the support
area came with long black candlestick2.
AMGEN- DAILY
*l'n*\c\n-
75
75
7E
55
70
,,**uiln'n'rPt'Tto*'nrf
60
200 Day
Moving
Average
55
55
(2)
50
55
50
50
15
45
40
40
35
nln'r*or,l+
35
'gz
NOU
0Ec
'93
FEB
IlAR
EXHIBIT 2.21. Long Black Real Body BreaksMoving Average support, AmgenDaily
The Basics 33
;";
f
EXHIBIT 2.22. Long Black Candle as Resistance
Long Black as Resistance
As a long white real body acts as a support area, so a long black real
body should act as resistance(seeExhiblt2.22).In Exhibit 2.23,longblack
real body L penetrated an uptrending support line. With the long black
candle at 1 and the long black real body six weeks earlier (at X), there
-WEEKLY
UPJOHN
49
19
48
4B
17
17
16
45
11
.13
fiuNl r+l
fiil
(x)
16
45
44
43
12
(1)
1L
40
5E'
37
42
41
40
39
3S
l1
v
%
36
35
34
35
34
33
,-d'*'f
n
3Z
31
30
5t
{tl
,91
JUN JUL AUG SEP OCTNOU OEC
,92
FEB IIAR APR NAY JIJN JI.[. AIJ6 SEP OET
EXHIBIT 2.23. Long Black Candle as Resistance,Upjohn-Weekly
34
Candles
was now a resistancezone that could be used to exit longs or to go short,
on a bounce to that resistance.
Exhibit 2.24 displaysa price explosion via a long white candle in late
1991'.Using the theory of long candles, let us see how one could have
traded this market. A long white candle gives us a support area at 50o/o
within its real body. Consequently, a pullback to near the 50o/oretracement of the long white could be used as an early buying zone. This could
have been at areas 1 through 4. Now, we turn our attention to a price
-suptarget. Notice the exceptionally bearish long black real body from
tember 1991,(at the arrow). As discussedabove, we would expect a raliy
to stall as it approachesthe top of this black candle. Although the bulls
were finally able to gather enough force to breach this resistance of the
long black candle, it took them over a year to accomplish this. Thus,
buying on a pullback into the long white with a minimum target to
september's long black real body could have been an effective trading
strategy.
AMEX_ WEEKLY
30.0
29.5
29.o
28.5
28.0
27.5
27.O
26.5
26.0
25.5
25.0
24.5
24.0
?3.5
23.O
2?.5
22.O
2 1 5.
21.0
30.0
rl^ |l? 29.0
?AF
28.5
28.0
27.8
zt -u
26.3
?6.0
25.5
%.0
24.5
24.O
23.5
23.CI
22.5
22.O
21.5
2L.O
zu.a
20.0
t 5.5
ls.0
18.5
18.0
'91
zu,5
tfl+t1tfl-
20.o
19.5
ts.0
rB.5
LB.0
,gz
EXHIBIT 2.24. Long Black Candle as Resistance, Amex-Weekly
J
35
The Basics
Size, Frequency, and Color of Real Bodies
The tone of the market can be gauged by comparing the relative height,
frequency, and color of a group of candle lines. The first sign of trouble
in Exhibit 2.25 came with the long black candle at L. Note how this is the
longest black candle in some time. Then, an aPPearanceof an elongated
black candle at 2 was an evident warning sign of trouble. The price descent continued until February's tall white candle at 3 arose. This was
the loftiest white real body in many months, and relayed that the bulls
had entered the market in force. Observe how the midpoint of February's
white real body became a base for a minor rally.
In the boxed section in Exhibit 2.26, we see a period in which the
market was trading laterally. With a bar chart, it would be difficult to
glean information about the relative strength of the bulls or the bears in
such an environment. With the candles,however, we can do this. In this
trading range environment, we can see that there were eight black real
BRISTOLMYERS- DAILY
72
72
al
7L
70
59
7E
. L
53
bu
68
67
67
bb
66
65
65
61
61
63
63
62
62
6L
bt-
50
60
5S
53
5U
58
57
57
56
56
55
55
54
54
53
53
,92
NOU
OEE
,93
FEB
IlAR
APR
MetaStockbY EQUIS Int'l
EXHIBIT 2.25. Slze and Color of Real Bodies,Bristol Myers-Daily
)
36
Candles
EXHIBIT 2.26. Relativesize, Frequency,and Color of Real Bodies,August 1993
Crude Oil
bodies and only four white candles.Also, the black real bodies were taller
than the white ones. With more and larger black real bodies than white
real bodies, the candlestell us that the bears were taking a more aggressive stancethan were the bulls. ClassicWestern technical theory stated
that after a congestionband, the market's trend should have resumed in
the same direction that it had before the congestion band. In this example, the preceding trend was down. Thus, the bearish candle action
during the lateral range reinforced the classicwestern theory and increasedthe odds of a continuation of the preceding downtrend.
In the next section, using information on how the open comparesto
the close will be discussed.But before that, I will discuss new ways of
interpreting candle patterns. This methodology will help illuminate the
theory and market action behind eachcandlepattern. Eachcandlepattern
in this book will be illustrated four ways (refer to Exhibit 2.22).
Exhibit 2.27 (B) The blended candle-If the candle pattern has more
than one candle line, you can combine them to make a single candle line,
which I call ablendedcandle.This method is sometimesused in the ]apanesecandlestickliterature to help clarify whether a pattern is bullish or
bearish. The blended candle is an individual line that is a combination
of the open, high, low, and close of all the candle lines in the pattern.
The Basics
7
37
Highof the Pattern
F---------
c
o
"1.
I
Lowof the
pattern
(A)
CandlePattern
TI" "_f""\"
(B)
BlendedCandle
(c)
Anchor Chart
(D)
DirectionalPattern
Analysis
EXHIBIT 2.27. Candle Pattern Analysis
As shown in Exhibit 2.27 (B), the blended candle is drawn using a fourstep process:
1. Use the open of the first sessionof the candle pattern as the open of
the blended candle.
2. Use the high of the candle pattern (in other words, the top of the
highest upper shadow) as the high of the blended candle.
3. Use the low of all the sessionsof that pattern (i.e., the bottom of the
lowest lower shadow) as the low of the blended candle.
4. Use the close of the last sessionof the candle pattern as the close of
the blended candle.
Based on the insight offered by the blended candle line in Exhibit
2.27, we can deduce that the two-candle combination in Exhibit 2.27 (A)
is a bearish combination. This is becausethe blended candle shows the
bearish aspectsof a long uPPer shadow and small real body near the
bottom of the range.
Exhibit 2.27 (C) Anchor charts-Those who draw the candle charts by
hand and are tracking many markets or are restricted in time may find
this task to be burdensome. One way to circumvent this (besidesbuying
software) is to consider using anchor lines instead of candle lines. The
anchor chart as previously discussed, is composed of the open, high,
low, and close. If the anchor is pointing uP, it means that the close is
higher than the oPen (with the arrow part of the anchor rePresenting the
close).An anchor pointing down means that the closeis lower than the
oPen.
Although the anchor chart is less visual than the candle chart, it provides the same information and is faster to draw. The disadvantageto
the anchor chart is that you don't have the quick color clue, as you do
38
Candles
with the candle's white and black real bodies. But you can draw up
sessionsin red and down sessionsin black (remember, however, that
unless you have a color printer, all the anchor lines will be black when
a hard copy is printed).
Exhibit 2.27 (D) Directional pattern Analysis-To clarify the market,s
path that unfolds during the candle pattern, I will draw arrows reflecting
the market's basicintra-sessionaction. I call this directionalpatternanalysii.
The path shown by the market's action in the directional pattern anaiysis'
can be used as a rough method to gauge the overall price action during
the session.Although the arrow in the directional pattern analysis will
show the path taken by the market during the sessfon,it will not show
the order of when these prices where touched.
For example,based on the relationship of the real body and shadows
of the first white candle in Exhibit 2.27 (A), we know that, at some time
during the session,prices moved under the opening price. However, we
do not know when the price moved under the open. \Atrhilethe arrow in
Exhibit 2.27 (D) may make it appear that the market immediatelv moved
lower after the opening, it may not have unfolded that way. The market
instead may have rallied after the open and later in the sessionfell under
the opening price. Thus, it is important to keep in mind that the directional pattern analysis should be thought of as a visual clue about the
relative price action of the open, high, low, and close compared to one
another. However, it does not tell us the sequenceof that price action.
Opening Compared to Prior Real Body
A disadvantageof candle charts is that they require the closeto complete
the candle line. There are some ways around this limitation. One t,.thod
is to go to a shorter time. In other words, if you are looking at a daily
chart, you can sometimesget a signal on the hourly chart before the close
of the daily session.Another mechanismto bypasi waiting for the close,
and the one I will focus on here, is comparing the opening to the prior
real body.
Exhibit 2.28 (A) illustrates that if the opening is under the midpoint
^Conof the previous white real body, it could be a bearish scenario.
versely, if the next day's opening is above the black body's midpoint, as
shown in Exhibit 2.28 (B), it courd be viewed ur u poiitive sign. This
concept might be useful for those who are more aggressive"r,d ,irkoriented and would want to buy or sell on an opening rather than waiting
for a close.
This technique is more important for stocks than for futures. This is
becausethe futures market's higher volatility makes it more likely for the
The Basics
39
h
EXHIBIT 2.28. (A) The
Traditional Candle Line or
Pattern
l l
I1
1 /
\"
EXHIBIT 2.28. (B) Opening
Comparedto Prior Real Body
price to open away from the prior close (remember that for prices to open
above or below the prior real body's midpoint, it has to open away from
the prior close). However, for a stock, such an occurrence is rarer, and
as a consequence more significant.
The chart of Manville (Exhibit 2.29) gave three signals that it was in
ffouble in mid-1992.First was the long upper shadow candle at the arrow
(shadowsare discussedin detail in the next sectionof this chapter). This
showed the market rejected the $11 zone. The next signal was when
Manville opened under the center of the prior white real body. Final
bearish confirmation came the following week when the market gapped
lower.
In Exhibit 2.30, inthe sessionmarked by the arrow, the market opened
above the midpoint of the prior black real body. This positive develop-
40
C-andles
MANVILLE- WEEKLY
.o- UPPer
shadow
tn F
10.5
l'10.0
10.0
s.5
9.5
s.0
9.0
+rI|,iliil+
9.5
s.5
8.0
7.5
7 n
8.0
,ttl',i*f,[t*'
7.5
7.0
5.5
6.5
'gl
N
0 '92
F
11 A
f1
J
J
A s
o
N o
,93 F
tl
A
fl
J
EXHIBIT 2.29. Open Under the Center of Prior White Real Body, Manville-Weeklv
ment was reinforced by the white candle's high volume activity. This
volume showed the pressure of the buying force.
Spinning Tops
we have seen the power inherent in tall white or black real bodies. A
tall white body reflectsa strong sessionin which the bulls are in control,
whereasa long black real body means that the bears are in charge.Now,
what would it mean if, instead of tall real bodies, there were small real
bodies?This would tell us that the bulls and bears are in a tug of war
and that there is more of a balancebetween supply and demand. Such
small real bodies, called spinning tops, tell us that the power to move
up or down is lacking, or as the ]apanesephrase it, the "market is losing
its breath."
As shown in Exhibit 2.3L, these are spinning tops even if the lower
and/or uPPer shadows are large. It is the diminutive size of the real bo$r
The Basics
- DAILY
RUBBERMAID
35.0
35.0
34.5
34.5
34.0
34.0
? 2 F
33.0
32.5
32.5
5t-u
5Z.U
3r.5
3 t .5
3t.0
?1 n
30.5
30.5
30.0
30.0
2S.5
29.5
23.0
?qn
28.5
28.5
,E3 F
t5
to
L2
EXHIBIT 2.30. Open Above the Center of a Black Real Body, Rubbermaid-Daily
that defines a spinning top. A spinning toP is a warning sign that the
market is losing its momentum. For instance, if the market is at or near
a new high-especially after a steep advance-the emergenceof a spinning top could be a signal that the bulls are having trouble in continuing
their ascent. This could be a cautionary signal that the prior move is
stalling.
In Exhibit 2.32, the strong, long white real bodies at the end of July
left no doubt about who had control of this market-the bulls. But the
two spinning tops after these long white real bodies sent out a warning
il
Real body can be
black or white
EXHIBIT 2.31. Spinning ToPs
41,
42
Candles
EXHIBIT 2.32. Spinning Tops, Dow |ones-Daily
that the bulls were unable to maintain the momentum of their advance.
The arrival of the spinning tops showed that the market was losing its
vitality. The black candles after the spinning top added more reason to
suspecta turn.
Accumulation and Distribution
One of the most powerful and important aspectsof candle charts is their
ability to meld themselves with any other form of technical analysis. Let
us, for example, uncover how one candle (the spinning top), combined
with volume, can provide critical information about the inner workings
of the market.
Two key conceptsrelating volume to price action are those of accumulation and distribution. Accumulation occurs when, at a low price
level, there is a high volume session with stagnant prices. The high volume relays that the bears are attacking full force, throwing all their re-
The Basics
sourcesand ammunition into the fray. But the stagnant prices during the
sessionshow that the bears are unable to drag down prices. All that the
bears have tried to sell has been accumulatedby the bulls. After such a
scenario,the bears may either run out of ammunition of just give up.
The consequenceof either of these is a rally.
Distribution is the opposite of accumulation. Distribution occurswhen,
at a high price level, there is heavy volume but virtually frozen prices.
"smart" money
What is happening in such an environment is that the
is thought to be distributing their supply to meet all the buying that is
entering the market. With distribution, the sellers are offering enough
supply to meet all the buyer's demand, thus keeping prices in check.
Distribution should therefore be viewed as a topping scenario.
Note that as part of the definition for either accumulation or distribution, there must be little price movement. A spinning top reflects a
session in which there is little price action (as defined by the difference
betweenthe open and the close).So, by combining volume with spinning
tops, we can determine when there is accumulation or distribution.
EXHIBIT 2.33. Spinning ToPs and
Accumulation, April 1993Crude OilDaily
43
44
Exhibit 2.33shows that a spinning top candlestickemergedon January
12. Note also the heavy volume of that session.As describeabove, stagnant prices and high volume at a low price level are classic signs of
accumulation.The high-volume spinning top in this example shows that
the selling Pressurewas easily absorbed.This positive sign was further
reinforced by the fact that this spinning top sessionmade a new low for
the move, yet the bears were unable to maintain these new lows.
In Exhibit 2.34, June's tall white candle sessionwas also a high-volume session.This was a very bullish development insofar as the market
moved up sharply with strong buying interest (as gauged by the high
volume). However, what occurred in the next sessionwas causefor concern. In that session, a small real body (i.e., a spinning top) emerged.
The volume on the spinning top session (circled on the chart) was not
as extreme as it was the prior day. Yet, looking back at the volume at
the bottom of the chart, we see that it was nonetheless a very highvolume sessioncompared to the prior periods. Consequently,there was
a high-volume spinning top session. \rvhat does that tell us? The high
volume reflects a market in which the bulls came out in force, but the
small real body-the spinning top-means that the bearswere aggressive
enough to almost stalematethe bull's advance.This action was a classic
sign of distribution. The small real bodies over the next few sessions
EXHIBIT 2.34. spinning Top and Distribution september 1991silver-Daily
The Basics
45
continued to echo the inability of the bulls to propel this market. Note
how the longest real bodies following the spinning top were black. This
showed that the bears had gained a foothold on the market.
Doii
One of the more important individual candlestick lines is the doji. As
shown in Exhibit 2.35, a doji session has a horizontal line instead of a
real body. This is becausea doji is formed when the session'sopen and
close are the same (or almost the same). If the market is trading laterallv,
a doji is neutral. In essencethe doji is echoing, on a micro scale, the
indecision reflected on a more macro scale by the market's sideways
action. However, a doji that emerges after the mature part of an uptrend
or sell-off has a gteater chance of a market turn. At such a time, the
"a hint of tops and bottoms."
Japanesesay that a doji provides
One should be especially cautious about a doji that arises after a tall
white candle which in turn aPPearsafter a significant uptrend. This is
true whether the doji is within the prior long white real body or above
it. Such action representsa disparity about the state of the market. Specifical$, the rally and tall white candles during such a rally tell us that
the bulls are still in charge. But a doji means that the bulls are failing to
sustain the upside drive. This is shown in Exhibit 2.36.
How do you decide whether a near doji day (i.e., where the open
and closeare very close,but not exact)should be considereda doji? One
method is to look at a near doji day and compare it to recent action. If
there is a seriesof very small real bodies, I would not view the near dOji
day as significant since so many other recent periods had small real bodies or doji. (Other methods are covered in my first book).
As mentioned before, a doji is meaningful when it arises after a tall
white candle during an uptrend. In this scenario,the market is consid-
'{l+I l,uu,n
r,il.
t
I
Examples of Doii
EXHIBIT 2.3s. Doii
I
"
r'il*
l
EXHIBIT 2.35. Doji After a Tall White Real Body
46
f;tr
il
I
'l
I
EXHIBIT 2.37. Doii as Resistance I
ered by the Japaneseto be "tired." Also, as shown in Exhibit 2.37, the
top of a doji session(that is, the top of the upper shadow) often represents resistance.However, if the highs of the doji sessionare exceeded,
then the market's uptrend should continue. This is discussedin more
detail below.
A common mistake among those who use canctes is to use a doji as
an outright buy or sell signal. This is not correct. The doji indicates, as
the japanesesay, "a crossroadsbetween the bulls and the bears." While
the doji can mean the market may reverseits prior trend, traders should
view the doji as echoing a market in transition rather than being an
outright reversal pattern. Based on this, traders should wait until the
next sessionor two after the doji to show them which way the market
will move.
If there is a doji during a rally, and if the market continues strong
after this doji, it is a bullish indication sincethe market has resolveditself
from the state of transition (as shown by the doji) to its new trend-up.
Thus, while a doji that appears after a rally could be an indication of a
reversal(sincethe market is at a crossroads),it is best to wait for bearish
confirmation over the next day or two to get a top reversalconfirmation.
For those who sell on a doji, the doji should act as resistance(seeExhibit
2.37). If the market closesabove the high of the doji, the japanese say
the market has become "refreshed." Based on this, a buy stop should
be placed above the high of the doji. The opposite would be true with a
doji in a downtrend. To wit, a doji in a downtrend shows that the market
is at a point of indecision, and a white candle after such a doji shows
that the market has resolved itself to the bull side. A buy based on the
doji after a downtrend should have a sell stop under the doji's low (including the lower shadow). This is becausesuch a scenariois viewed as
a bearish continuation signal.
one of the most fascinating aspects about candle charts is that, in
spite of their underlying simplicity, they provide so much valuable information about the state of the market. For example, what is more il-
The Basics
0""
, ,+Tr
I
I
doji'---> f
doli--'-----+f
,l
t l
(A)
l , '
(B)
ooii----- -l(c)
EXHIBIT 2.38. Doji After Extended Move
lustrative of a market in balance than a doji? That simple, individual
candle line relays how a market is in a state of balancebetween the bulls
and bears. As a result, the market may be at a transition point. All this
information in one candle line!
An important aspectabout doji (the plural of doji is also doji) is that
traders should look at where the doji appears in a trend. Exhibit 2.38
shows a doji in relation to the trend. As in Exhibit 2.38(A),the appearance
of a doji after a steep advance or in an overbought market could be a
top. However, as shown in Exhibit 2.38(8), if the market just started to
rise, it indicates there is less of a chance that the market is at a top. In
Exhibit 2.38(C)we see how the emergenceof a doji after a precipitous
decline could mean a bottom. Exhibit 2.38(D)displays a market that has
just begun to fall. In this scenario,prices may continue their descenteven
after a doji. The main concept behind Exhibit 2.38 is that doji become
more important as a reversal signal the more overbought or oversold the
market.
In Exhibit 2.39,we notice a rally that startedin early November stalled
after two doji following a tall white candle. The appearanceof these doji
told of a market in which the bulls and bears were in equilibrium. This
was very different from the prior session when the tall white candle
displayed a vibrant and healthy market in which the bulls were in control.
"the
These doji were showing, as the fapanese would phrase it, that
market is separatingfrom its trend."
As discussedbefore, doji becomeresistance.In this chart, there is also
a long black real body candle (at the arrow) a few days after the doji.
This black real body should also be resistance.With this in mind, the
doji sessionsand the long black real body provided a resistancezone in
(D)
47
48
&ndIes
GAP _ DAILY
38.0
77F.
77 tr,
32.0
27n
7( tr,
?(6
JD, U
?66
?q6
oo,iloil
?4q
?4n
?EN
?46
??6
< <
t l
?1 tr
JLr
J
af
| |
9rn
? t 6
J T .U
ni n
JI. U
?NF
?n6
30.0
30.0
)q6
'92 09 15 23 D 0Z
11 2t 28 '93 tl
t8 25 t
08 16 22
08
EXHIBIT 2.39. Doji After a Tall White Candle, Gap-Daily
the $37 to $38 area. It was within here that the market failed during the
early 1993rally.
The arrow in Exhibit 2.40 points to a doji sessionin which the open,
low, and close are at the bottom end of the session'srange. This doji is
known as a gravestonedoji. A gravestonedoji looks like a wooden memorial used in Buddhist funerals that is placed at a gravestone.It is said
that those who buy at a high price level after this doji will die and become
ghosts. (Thosefamiliar with candle patterns will note how this doji was
part of a classic evening doji star pattern [this pattern is discussedin
Chapter 3l).
Exhibit 2.41 shows how the small real bodies at 1 and the doji at 2
warned that the market was losing its upside drive. After trading in a
lateral range for a few weeks, prices ascendedto new highs in late ]anuary. However, there were two clues that the rally might not be sustainable. The first was the doji at 3. This showed that, although the market
had reachednew highs, the upside drive had stalled. Another clue was
The Basics
EXHIBIT 2.40. GravestoneDoji August 1993Natural Gas-Intra-Day
provided by the rate of change (ROC) oscillator.This oscillatorcompares
today's closing price to that of ten sessionsago.
For this example, I show the ten day ROC. This compares today's
close to that of ten days ago. With a healthy market, traders would like
to seean increasingROC oscillator.This reflectsthat the market's upside
momentum is growing as prices are ascending. However, note how at
doji 2, Dell touched a new high, yet the ROC oscillator was at a lower
reading than it was at the prior highs in December.This underscoresa
slackening of the upside drive.
Thus, the ROC oscillator helped reinforce the bearish implication of
doji 2. As further confirmation of a top, there was the long black candle
on the day after doji 3. A few days after this black candle, the ROC
oscillatorfell under 0 (some techniciansview that as a time to sell). This
chart is an exampleof how easyit is to combine the candleswith Western
technicaltools.
49
50
Candles
DELL& 1OPERIODROC
02123r33
0
-25
'T{lu,*o*hl;+T
"*il'.
-Ff '
'1,
{9
{8
17
15
15
11
4?
12
4L
{0
lF
19
18
17
16
15
11
13
12
4L
10
'Totrrrril+rtT
.';
?q
<K
JU
37
36
37
36
?E
?6
31
31
JJ
37
JL
'92
2l
2g
'93
11
t8
tt
OB
t5
22
EXHIBIT 2.41. Doji and Momentum, Dell-Daily
SHADOWS
While the real body is often considered the most important segment of
the candle, there is also substantial information to be gleaned from the
length and position of the shadows. Thus, the location and the size of
the shadow should also be considered when analyzing the psychology
behind the market.
A tall upper shadow is especially important when it appears at a high
price level, at a resistance area, or when the market is overbought. This
is becausesuch a candle line would hint that there is either heavy supply
entering at higher prices or an evaporation of buying. In either case(see
Exhibit 2.42), a long upper shadow could be a bearish development. A
long lower shadow candle that bounces from a support area, or appears
in an oversold market, could be an important clue that the bears are losing
control.
The Basics
l l TI
Bearish-Long
Upper
Shadows
Bulllish-LonoLower
Shadoils
EXHIBIT 2.42. Long Shadows
In Exhibit 2.43, in early L992there was a hint of trouble with the doji
following the tall white candle. Remembering the concept that the doji
sessionshould be resistance,the market stalled at the doji's high over
the next two weeks. The two candlesafter the doji had long upper shadows. Theseshadows displayed that there was either very aggressiveselling near the 109level, or that buying quickly evaporatednear thesehighs.
In either case, these long lower shadows showed a dampening of the
rallying strength. Further evidence of the importance of this resistance
was the failure there in mid-1992.
Exhibit 2.M displays that candles L, 2, and 3 rebounded from near
59Cvia long lower shadows. These long lower shadows reflected the
solidity of the support and the eagernessof the buying. Also important
was the length of the base that had been built. For almost two months,
EXHIBIT 2.43. Long Upper Shadows Confirm Resistance,Notionnel Bond-Weekly
51
52
Candles
EXHIBIT 2.44. Long Lower Shadows Confirm Support, fune 1993Deutsche MarkDaily
the bears tried to break prices under 59c and they failed. In general, the
longer the base, the more solid the scaffolding on which a rally can be
built.
A popular moving average among futures traders is the 65-day moving average. This line often swerves as support or resistance. For example, note how in Exhibit 2.45 that it was support in early November
and again in early |anuary. The test of this support in early fanuary via
long lower shadows, shows how strongly and quickly the market sprang
from there. For those who are familiar with candles, the first long lo*",
shadow candle is a hammer. Hammers will be explained in the next
chapter.
High-Wave Candles
A candlewith a long upper and lower shadows is calledahigh-wnaecandle
(shown in Exhibit 2.46).It shows that the market is in a standoff between
the bulls and bears. when a high-wave emerges after a downtrend or
uptrend, the |apanesesay that the market has lost its senseof direction.
This lack of market orientation means that the prior trend is in jeopardy.
The Basics
EXHIBIT 2.45. Long Lower Shadows Confirm Support, March 1993S & P FuturesDaily
A doji that has long upper and lower shadows is either called a highwave doji or a long-legged doji.
In Exhibit 2.47, a series of high-wave candles are displayed at 1', 2,
and 3. The high-wave candle at L hinted that the bulls and bears were
at a standoff. The action that precededcandle t had a bearishbias. Thus,
with the appearance of high-wave candle 1, the market had sent out a
clue that the trend was probably in the process of change. This outlook
was reinforced by the dual white candles after high-wave candle 1. The
market ascendedfrom candle L until it got to another high-wave candle
(at 2). From there, prices declined sharply in the next sessionvia a long
black real body. However, at the sessionafter this long black real body,
a candle with an extended lower shadow (at X) showed that the lows
I
EXHIBIT 2.45. High-Wave Candles
53
54
Candles
CRUDE
OIL- DEC.1993
19.5
19.5
19.0
19,0
1 06
lB.5
lB,0
rB.0
17,5
t7.5
lz.0
li.0
l
/
f
16.5
lb,3
33
3 0 s07 l 3
20
lt
IB
?5
OB 15
MetaStockby EQUIS Int'l
EXHIBIT 2.47. High-Wave Candles, December1993Crude Oil
from the prior week had become an attractive buying area. As prices
ascendedfrom candle X, a whisper of trouble emergedvia the high-wave
candle at 3. Two days later the long black candle showed that the bears
had entered the market in force, and as a result, increasedthe likelihood
that the high-wave candle at 3 was a top reversal.
CHAPTER3
THE PATTERNS
HE6if6--.3tZE6D
"He WhoseRanksare United in PurposeWiIl Be Victoious"
Dince the publication of my first book, I have had new ]apanesematerial
translated, have met new Japanesetraders, and have continued my dialogues with those japanese traders who have previously helped me. In
addition, I have also had another three years of hands-on experience.As
a result, I have gleaned new insights and conceptsthat will be conveyed
to you in this chapter.
This chapter will not be a reference to all the patterns that are in my
first book. Instead, my aim here is twofold. For those new to candles,
this chapter will reveal how some of the more common and important
candle patterns can provide powerful insights into your market analysis.
For those already knowledgeable about the candles, you will discover
new refinementsand trading techniques.It is especiallyimportant to read
the detailed descriptions of the charts. It is in these that you will most
easily seesome of the new refinements of candle theory, as well as some
new concepts.
As one of the Japanesebooks I had translatedstated, "the psychology
of the market participant, the supply and demand equation, and the
relative strengths of the buyers and sellers are all reflected in the one
candlestickor in a combination of candlesticks."l In this chapter, I will
describethe many uses and trading insights provided by individual candle lines and candle patterns based on two or more candle lines. The
organization of this chapter is based on the number of lines that form
the pattern. Consequently, this chapter's first section will focus on individual candle lines, such as the hammer and shooting star. The next
section will delve into candle patterns comprised of two candle lines.
55
56
Theseinclude the dark cloud cover and two gapping black candles.The
final section in this chapter will address those candle patterns, such as
the evening star and record sessions,which have three or more candle
lines.
SINGLE CANDLE LINES
In Chapter 2, I detailed how the length of the shadows can relay information about the resiliency of the bulls or the bears. For example, a long
upper shadow echoes the ability of the bears to regain control of the
market during a rally. A long lower shadow pictorially reflects the bulls'
ability to rally the market after the market's new sessionlows have been
made.
In this section, the single candle lines I will be describing (the hammer, hanging man line, and the shooting star) either have a long upper
or lower shadow. But, becausethey also possessthe important aspectof
having a small real body near the top or bottom of the trading range,
these candles lines take on increased importance when using candle
charts.
The Hammer
As shown by Exhibit 3.1-,the hammer, with its long lower shadow and
a close near or at the high, is easily understood to be a bullish signal.
The term "hammer" derivesfrom the fact that the market is "hammering
out a base," or that a bottom is so solid that it does not break, even
when a hammer knocks away at it.
,,1
EXHIBIT 3.L. The Hammer
V
ThePatterns
An aspect of the hammer is that it must appear after a significant
downturn or in an oversold market to have significance.The hammer is
a reversal indicator, and as such, should have a downtrend to reverse.
A hammer that appears after a fall of, say, two or three days is usually
not important. Since the hammer is most useful after a significant downturn, it should be noted that there may be selling on a rally from the
hammer. As such, the first bounce from the hammer may fail and the
market may return to test the hammer's support.
Consequently,trading with the appearanceof a hammer depends on
a trader's aggressivenessand risk adversity. Some traders may decide to
buy immediately after the hammer appearsin casethe market does not
pull back to retest the hammer. Some traders may decide to wait to see
if the market returns to the hammer, and if so, will buy on that return
move. If the market successfullytests the hammer's support area, there
is then a more solid support areaand a better chancefor a rally. A method
that I sometimesrecommend to our clients is to lightly test the waters
from the long side after a hammer, and then add the remainder of the
long position after (and if) there is a successfultest of the hammer.
Whichever methodology is used, a stop (based on the close) could be
placed under the lows of the hammer.
Exhibit 3.2 displays a classichammer in that the extreme length of
the lower shadow reflectshow aggressivelythe bulls were able to propel
prices off the lows of the session.The bounce from this hammer stalled
during the next few sessions.But the pullback held the hammer's support. This action helped enlarge the base upon which to build a more
substantial rally.
A trading tool that I find useful with candles is a Western technique
called a spring.As shown in Exhibit 3.3, a spring occurs when the bears
are unable to hold prices under a broken support area. Becausesuch
action proves that the bears were unable to grab control of the market
when they had their chance, it should be viewed as a bullish development. The opposite of a spring is an upthrust.An upthrust occurs when
the market makes a new high, but then fails to hold that high. Upthrusts
will be addressed in the section titled "The Shooting Star" later in this
chapter. (Springs and upthrusts are describedin detail in my first book.)
An ancient oriental book on military tactics referred to gaining an
advantageover the enemy by acting as a "moving shadow." This term,
asused by the warrior who wrote that book, meansthat when you cannot
see the state of your opponent, you pretend to make a powerful attack
to uncover the intention of the enemy. This concept,as related to trading,
is one of the reasonsa spring is so important.
Probes of support or resistanceareas are attempted throughout the
markets by large-scaletraders. They want to discover how the market
57
58
Candles
AMGEN_ DAILY
7g
78
79
7B
77
76
75
71
73
72
7l
70
6S
68
67
66
65
61
63
62
6l
60
59
5B
57
56
)7
7S
7q
71
1a
I J
72
7l
70
68
67
bb
65
61
63
[ilrItil'+rIr-i
+rl-+++l*oril
*r,n+r\1n*ilta4ill1rt,*,,,,0,*tn*
bt
6l
60
59
5B
57
56
'92
Hammer
|
S
08 t4
2t
28 0
'"'t
t2
19
26
N
09
16
23
D
MetaStock
by EQUISInt'l
EXHIBIT 3.2.
Hammer as Support, Amgen-Daily
will react once a support or resistancearea is pierced. In effect, these
traders act like the aforementioned "moving shadow," testing the battlefield by entering a large order to try and break support (or resistance).
For example, if a large-scaletrader places a sell order as the market gets
near support, their sell order may be enough to drag prices under the
support area. Now, this trader, as a "moving shadow,,, will now learn
about the underlying strength of the market. If the market fails to hold
under a broken support area and forms a spring, these "moving shadows," (i.e., the sellers who were attempting to probe the market), now
have learned about the tenacity of the bulls and as a result may decide
to cover their shorts.
", ," ",
Suppod
EXHIBIT 3.3. Spring
,"',,""
\_
\Sprins
The Patterns
EXHIBIT 3.4. Hammer and a Spring, Gold-Weekly
In Exhibit 3.4, we seeone of the more powerful combinationsof Eastern and Western technicals-a hammer and a spring. The 1993low was
formed by a hammer. This hammer was also a spring since the low of
the hammer's lower shadow stightly punctured a support zone, but
sprang back above this broken support line. Also of interest in this chart
is that the high made near $360in mid-1992rwasformed by a doji following a tall white candle.
The Hanging Man
As shown in Exhibit 3.5, a hanging man has a very long lower shadow,
a small real body (white or black) near the upper end of the trading range
and little or no upper shadow. This is the same shape as the hammer
"If it appearsfrom
line. However, as expressedin the Japaneseliterature,
below, buy, and if appearsfrom above, sell."
This phrase means that the same shape line can be bullish or bearish,
"from
depending on where it appears in a trend. If this line appears
below," that is, during a decline, it is a bullish hammer. However, if this
same shape line appears "from above," that is, during an uptrend, it is
a sell signal and is referred to as a hanging man line.
59
60
,,Black
,_rr or White
crose
shourd
be
I l-
,|
,I
l
l
EXHIBIT3.5. The HangingMan
underhangingman's
reatbody
|
l
T
l
I
Thus, the hanging man line is a top reversal signal that must arrive
during a rally, while the hammer is a bottom reversal line that must
appear during a decline; the same line can be bullish or bearish, depending on the trend preceding it. In this context, it is interesting that
the japanesehave two words for rice. They call it either "raislJ,, oi ,,gohan." Raisu is the |apanese term for rice when it is prepared westJrn
style. The term "raisu" even sounds like the western word "rice.,, Gohan alsomeansrice, but it is rice prepared japanesestyle. In other word.s,
the Japaneserefer to the exact same product-rice-by different names.
\tVhat surrounds the rice determines whether the rice is referred to as
raisu or gohan. So it is with the hammer and hanging man. whether the
candle line is a bullish pattern (the hammer) or a bearish pattern (the
hanging man) is dependent on what precedesthe line.
with the hanging man's long lower shadow reflectingbuying interest,
it may seem that the hanging man is a bullish signal. However, the
hangman's action shows that once the market has fallen, it has become
very fragile. The small teal body of the hanging man also shows that the
prior uptrend may be in the processof changing. Becauseof the bullish
action of the hanging man session(during the sessionthe market sells
off and then rallies by the close),an important aspectof the hanging man
lines is that there should be bearish confirmation. A common method of
bearish confirmation of a hangman is to wait to see if the next session,s
closeis under the hanging man's real body. This is shown in Exhibit 3.5.
The reasonfor the importance of this confirmation has to do with the
fact that the hanging man's long lower shadow shows that there is still
rising power left in the market. However, if prices fall under the hanging
man's real body, it translatesinto the fact that everyone who bought at
the open or close of the hanging man sessionis now losing money. In
such a scenario,these longs may decide to liquidate, and by doing so,
may engender a further weakening of prices.
since my seminar on the candles at the world Bank in washington,
The Patterns
61
C A I I D L ES T I C X ( D A I L I )
I
I
;r "'*[l
I . I I
'lr,
,'tl
,
r--HansinsMan
gu",-t:1
}-ffliil'
I
FteutersGraphics
trrr
EXHIBIT 3.6. Confirmation of
a Hanging Man, German
Bund-Daily
DC, some of their traders have asked my opinion on candle patterns on
various markets. One of their traders asked what I thought about the
chart of the German Bund shown in Exhibit 3.6. She asked my opinion
on April 10 after the hanging man was formed. I explained to her that if
the hanging man were confirmed by a weaker sessionthe next day, the
outlook would be bearish. In this case,the market confirmed the bearish
hanging man during the next session.
Exhibit 3.7 shows how important it is to wait for confirmation of a
hanging man session. In that chart, we see a hanging man. However,
note how the following week the bulls pushed prices above the high of
the hanging man. This means that those who bought during the hanging
man sessionnow have a profit. Consequently, there is little reason for
them to liquidate their longs. The result is that a higher close than the
hanging man sessionvoids any of the bearish potential of the hanging
man. That is what happened here as the market exceededthe hanging
man session.Also of interest in this chart is that in April 1992,there was
a hammer that was also a bullish spring, since the hammer made a new
low which failed to hold.
An article about my work with candles in The Wall Streetlournal displayed the chart shown in Exhibit 3.8. In this article, I discussedhow the
hanging man at $40 helped confirm a top. I explained that before the
1990Mid-east crisis, the highest crude oil futures reached was around
$32 (crude oil futures began trading in 1983).Once the market exceeded
that level, I had a target at around $40. That was a resistancearea in the
cash market back in 1979.Note that at the $40 area, there was a bearish
candle signal via the hanging man line. The market retreated from this
g40level and tested a support line. It then rallied and, with sort of a last
Candles
EXHIBIT 3.7. waiting for Confirmation of a Hanging Man, Bonds-weekly
EXHIBIT 3.8. Hanging Man Confirms Resistance, November 1990 Crude Oil-Dailv
The Patterns
",,,,",,,,",,,,"',,,
*ewResisrance
rorr*r Support
",,iT,
I
lr
rr
rr
rlr
t'
NewSupport
EXHIBIT 3.9. Change of Polarity Principle
gasp, the bulls temporarily nudged the market above $40before the floor
fell out of the market.
There is a basicWestern technicalconceptthat statesthat a penetrated
resistanceareashould then be convertedto support and a broken support
area should be resistance.I call this concept the changeof polaity pinciple
(it is discussedin detail in my first book). This conceptis shown in Exhibit
3.9. I find the changeof polarity a very useful tool, especiallywhen joined
with candles.You should find that the more often a support or resistance
area is tested before prices break them, the better the change of polarity
principle should work.
In Exhibit 3.10 we see that an evident support area from mid- to late
EXHIBIT 3.10. Hanging Man and the Change of Polarity Principle, March 1993 Crude Oil
63
64
Candles
November was slightly above $20. Once this important support was bro_
ken, the changeof polarity rule implied that this$2Or,rppori should then
becomeresistance.This is what unfolded as this $20 resistancearea was
confirmed with the mid-Decemberhanging man session.The long black
real body, also near $20, on December 28, showed that the bears had
taken control.
The Shooting Star
A session with a long upper shadow and a small real body near the
bottom end of the trading range is called a shootingstar (seeExhibit 3.11).
|ust as the long lower shadow of a hammer is bullish, so the long upper
shadow of the shooting star is bearish. The long upper shadow *eit s
that the bearshave been able to sharply drag pricesback from their highs.
In Exhibit 3.12,we seehow the mid-August shooting star,slong ulper
shadow reflectedthe aggressiveness
of the bears.Following this shooting
star, another symptom of market uncertainty came with ihe high-wave
candle. The fact that the shooting star and the high-wurr. .u.,lle both
appearednear the psychologicallyimportant 100 area reinforced the importance of those signals.
In Exhibit 3.13, I show how a support area from late August (marked'
s) changed to resistancethrough september and into october. The october failure of this resistanceareawas via a shooting star. The long upper
shadow of this line reflected the heaviness of supply towards the-1^.66
level. Another attempt to breach 1.66 failed in eariy october with a long
black real body.
In the section on hammers, I discussedthe concept of springs (when
the price springs back above a broken support area)utra tnui the opposite
of a spring is an upthrust. As shown in Exhibit 3.\4, an upthrust is
createdwhen prices break above a resistancearea, but then retreat back
under the previously broken resistance.This scenariohas bearish impli-
white I
3L*11
l r l
EXHIBIT 3.11.
The Shooting Star
The Patterns
EXHIBIT 3.12. Shooting Star with a High-Wave Candle, September 1993fapanese
Yen
EXHIBIT 3.13. Shooting Star and the Change of Polarity, Cash Deutsche Mark
66
Candles
EXHIBIT 3.14. An Upthrust
cations. At times, the upper shadow of a shooting star can also be part
of an upthrust.
In Exhibit 3.15, there is a shooting star that pierced the January7 and
8 resistancearea with its long upper shadow. The failure of the 6u[s to
keep prices in the new territory created a bearish upthrust.
To help clarify the difference between the hammer, hanging man, and
shooting star lines, I have annotatedExhibit 3.16with un "*u-ple of each
candle line. Note that for each signal the market must be in a clearly
defined trend.
L. Shooting star-we can see how the shooting star must appear after
an uptrend. The shooting star's long upper shadow reflects market
rejection of higher prices.
EXHIBIT 3.15. shooting star and Upthrust, March 1992Bonds-Intra-Day
ThePatterns
67
DISNEY_ DAILY
47.5
iliq,:ii"'Man@
47.0
16.5
16.5
dlll
hn' ilril-nsMan@
il||ttil
.l-,*s,,.r1'oil
\'
'-lryil|']h**
'o'rl
*rJlrrJ
",,,il
45.5
15.0
45.5
46n
14.5
44.5
41,0
41.0
4 ? 6
13.5
43.0
1t. x
12.0
13.0
42.5
llV
U
u
4?n
ammer
F - - H@
I'
4 15,
11.0
10.5
40.0
4 t .0
40.5
10.0
47n
46.0
46.0
1 15.
47.5
'92 2I
' 9 3 11
18
l b
22
I3
29
MetaStockbY EQUIS Int'l
EXHIBIT 3.16. Hammet, Hanging Man, and Shooting Star Lines, Disney-Daily
2. Hammer-A long lower shadow candle that must aPPearduring a
downtrend.
3. Although this has the correct shape of a hammer or hanging man line
(a long lower shadow with a small real body near the highs of the
session),candle 3 is neither a hammer nor a hanging man. This is
becausethis line did not aPPear during an uptrend or a downtrend,
but was in the middle of a trading range. Thus, line 3 is not a hammer
(although the long, lower shadow could be viewed as a positive signal).
4.,7. Rallies preceded these hanging man lines, which were confirmed
during the next sessionby a closeunder the hanging man's real body.
In line 7, we can see a small uppef shadow. If the uPPer shadow is
relatively small, it is still considered a hanging man. (A small uPPer
shadow is also allowable with a hammer.) Note how the real body of
the hanging man can be white or black.
5. This line has the correct shape of a shooting star (a tall uPPer shadow
and a small real body at the lower end of the session'srange). However, since it does not appear after an uptread, it does not have the
bearish implications as would a traditional shooting star.
68
6. This particular hammer should be viewed as being relatively unimportant since it appeared only after a minor downtrend. It did, however, show, via its long lower shadow, a successfultest of a support
area near $43 from the late |anuary and early February lows.
To summerize, always look at the preceding trend to determine if the
hammer, shooting star, or hanging man lines should be acted upon.
Rememberthat as reversal signals; they need a prior trend to reverse.
DUAL CANDLE LINES
In the preceding section, I looked at individual candle lines. In the remainder of this chapter, I will review some of the more important or
common candle patterns that are comprised of two or more candle lines.
Dark Cloud Cover
A dark cloud (shown in Exhibit 3.17) shows, as the Japaneseexpressit,
that the market has a poor chanceof rising. The dark cloud cover's first
candle is a strong white session.During the next session,there is buying
pressureleft over and the market opens higher, but later in that session,
prices decline as the market closesunder the center of the previous session. This pattern reflectsa period in the market when the upward power
of the tall white candle has been dissipatedby next session'sweak black
candle. Note how the blended candle line in Exhibit 3.17 has a longer
cand'e
lf close on second
day not under
middle of white -->
real body wait for
confirmation
p
/ \
II
EXHIBIT 3.17. Dark Cloud Cover
ThePatterns
upper shadow. In other words, the dark cloud cover displays pictorially
a time in the market in which selling Pressure is exceeding the buying
pressure.
An ideal dark cloud cover's second session should close under the
midpoint of the prior white candle. If the black candle does not close
below the halfway point, it is consideredby some fapanesetraders to be
an incomplete dark cloud cover. In such cases,it is best to wait for confirmation during the next session in the form of a weaker close. As a
generalrule, the deeperthe closeof the dark cloud cover's secondsession
pushes into the white candle, the more bearish the signal.
A dark cloud that fails to move under the center of the prior candle
is shown in Exhibit 3.18. Looking at the blended candle in Exhibit 3.18,
we seehow there is less of an upper shadow than in the caseof the more
classicdark cloud cover's blended candle shown in Exhibit 3.17. This
means the dark cloud cover in Exhibit 3.18 may be less bearish than a
standard dark cloud cover. This is why there should be confirmation by
further weakness after the type of dark cloud cover shown in Exhibit
3.18.
There is a difference in how I would view the dark cloud cover in
stocks and futures. The ideal dark cloud cover has the second session's
open above the high of the prior session.Since there is generally higher
price volatility in the futures market as compafed to stocks,it means that
I am more flexible about the definition of a dark cloud cover with stocks
than with futures. Specifically, with stocks I still view it as a dark cloud
cover if the second sessionopens above the prior session'sclose,rather
than its high. This is shown in Exhibit 3.19.
.fi;
I r--:-----------:r
II
I
I
I
EXHIBIT
Close of candle(2) above
midpointof candle(1)
3.18.
Dark Cloud Variation
I
I
1
Oo"nof candle(2)
abovecloseof candle(1)
EXHIBIT 3.19. Dark Cloud Variation 2
69
70
Candles
However, if the secondsessionof the dark cover of a stock does open
above the prior session'shigh (instead of its close), it would be more of
a potential reversal signal. This is becauseit is more bearish if the market
reverses after failing from a new high than it is if the market fails from
an area that was not a new high.
A dark cloud cover often becomesresistance.In Exhibit 9.20, we see
a dark cloud cover in late |anuary near 975.50.The market retreatedfrom
there until a hammer (that was also a spring) formed near 969 in February. The rally from this hammer stalled in March at the resistanceset
by the dark cloud. However, as with any form of technicalanalysis,there
should be a price at which you should reconsideryour original outlook.
For a pattern like the dark cloud cover, if the market closes above the
high of the dark cloud cover, the chancesare that the market will continue
its upward path. In this example,observehow the market not only closed
above the high of the dark cloud cover in late March, but did so via a
bullish rising gap. Another interesting aspectof this gap is that the ses-
SW BELL_ DAILY
B3
83
82
B2
81
80
Z9
7B
8l
BO
Z9
78
77
76
75
iltil
s**-df,1j'
77
e
t l
Dark Cloud
7+
76
75
7+
' 'r ' t'10*,,_,,00,/f
*1lriltlol+,pt,*Jot'lo.,,
lilI',o
,0il{r+nrilil*'+i,l,o,
rr,l,+il
73
73
72
7l
70
(L
7l
7D
ht
' 9 2 0 2t + 2 t z B ' $ l t
l B 2 5 F 0 B L 6 z ? f i 0 B1 5 z z 2 9 R 1)
MetaStockby EQUIS Int'l
EXHIBIT
3.20.
Dark Cloud
Cover as Resistance, Southwest
bJ
and Spring
F-Hammer
Bell-Daily
1q '(.
71
ThePatterns
sion after the gap createda shooting star. Yet the bearish implications of
the shooting star was not confirmed sincethe market failed to closeunder
the rising gap (this will be discussedin detail later in this chapter under
the section on "windows"). Thus, when selling short based on a dark
cloud cover, consider a stop on a close above the highs of that pattern.
For those who are looking to buy, you should consider it when on the
close, prices pierce the high of the dark cloud cover.
Exhibit 3.21 is an example of two less than ideal dark cloud covers at
1 and 2. Dark cloud cover L was not ideal since the second session(the
black candle) failed to close under the mid-point of the prior session.
Dark clorrd cover 2lost some of its bearishimportance becausethe second
sessionof the pattern opened just above the prior close instead of the
prior high. Yet, sinceboth of thesenon-classicdark cloud coversemerged
so close to one another, they served to reinforce each other. In other
words, both dark cloud coversreflected the fact that as prices made new
highs near $45, the bears were able to drag prices back down under the
EASTERNKODAK- DAILY
466
+5.5
4En
46n
++,5
446
++.0
++.
0
4?5
4?6
u
+3.D
+2.5
+2.0
41 6
+3,0
l,lil+ililolqt\10'
'*t
41 tr
"r,J
+2.D
4l
E
+1.D
+1.
0
+0,5
4n6
+0.0
+0.0
'92
t(
l 1
1D t (
08 1+
?B
t2 l 9 LD
MetaStockbv EQUIS Int'l
EXHIBIT
3.21.
Dark Cloud
Covers in Close Proximity,
Eastman Kodak-Daily
nq l 5
/<
72
Candles
HOcl Candlc Stick
,
il
Congestion
Band
-----;
(Dailrr)
DarkCloud
Cover
qi
t t0;ntnr,*ho,oo
rll
1,, , ^,ilI'fo+
T*'f4[onlr+[[+'
ReutersGraphics
EXHIBIT 3.22. Dark Cloud Cover Confirms Resistance,February 1993Heating Oil
prior closes.This is not a healthy scenario.The gap lower was final proof
of a break to the downside.
Exhibit 3.22 shows a congestionband between 59 and 60Qduring the
first half of November. When the market trends laterally for an extended
period, the congestion zone often becomesa resistanceor support area
once prices break out of that range. This is becausethe longer the market
trades sideways, the more traders get involved in the market as either
buyers or sellers. In this example, once prices broke under the bottom
end of the early November congestionband, those who went short while
the market was within the lateral band were making a profit on the
downside breakout. However, those who went long while the market
was within that early November trading band were in a losing trade when
prices broke under the bottom end of the congestionband. This means
that if the market rallies back up to the congestionband, those longs may
use that rally to try to get out of their losing trade. In other words, the
existing longs should be new sellerson rebounds to the congestionband.
In Exhibit 3.22, once the early November congestionarea was broken, it
then becameresistance.The Decemberfailure at that resistanceareacame
with the dark cloud cover (the empty area between the two candles of
the pattern was due to a holiday).
ThePatterns
The Piercing Pattern
As shown in Exhibit 3.23, the piercing pattern is the opposite of the dark
cloud cover. The dark cloud cover appearsafter an uptrend, and is comprised of a black real body that closeswell into the prior white body. The
piercing pattern is a white real body that closeswithin the prior black
real body. This pattern shows that there is fierce buying at lower levels.
The following is an interesting and graphic explanation used in a
]apanesebook to describe what happens during the formation of the
piercing pattern
the last of the bulls that were backedinto a cornerand cameout fighting
in a heroic fight. Kamikazefights are always frigh,tening,so the bears
seeingthis taketo the sidelinesfor the moment.In this quiet period,the
or after all the sellingthat has occurred,
bulls may get reinforcements,
the supply road for the bearsmay be alreadybroken."1
In other words, the downward energy of the market has been dissipated.
There are various names for the two candle patterns that have the
secondwhite candle close less than halfway into the prior black candle.
These are discussedin detail in my other book. For the purposes of the
discussionhere, these names are unimportant. What is important is the
generalconcept that the more the white candle piercesthe black candle,
the more constructivethe signal. If the white candle fails to move deeply
into the black candle, it reflects a weak counterattackby the bulls and
Closeabove prior black
/candle's center
\
j
t
f I +
I +l
i
EXHIBIT 3.23. The PiercingPattern
73
74
Candles
rrl
EXHIBIT 3.24. IA/hite Candle Under Center of Prior Black Candle
selling could resume. As illustrated in Exhibit 3.24, you can see that a
pattern that has the secondsessionbelow the midpoint of the prior black
candle createsa blended candle with a short lower shadow. Note, by
comparison,the long lower shadow of the blended candle in Exhibit 3.23.
This shows the bulls successfullymounted a strong counterattack.Also
considerthat the lower the secondcandle's opening, the longer the lower
shadow of the blended candle will be. This means that a pieicing pattern
that has a low opening secondsessionand then closeswell into the prior
candle would be an optimum example of that pattern.
DISNEY-
DAILY
,19
48
17
15
45
11
13
42
4L
.10
47
16
45
11
13
42
.ll
4B
39
38
37
%
35
34
33
32
3l
3tl
29
Piercing
Pattern
n
27
,9I
t}IC ,92
FEB IIAR mR NAY JI.['I JUL AUGSEP OCT NOUI]EC 'g3 FEB HARAPR
EXHIBIT 3.25. Piercing Pattern and Retracement, Disney-Weekly
39
38
37
36
35
34
33
32
31
30
29
28
27
lhe Patterns
It has been my experience that dark cloud covers are more prevalent
than are piercing patterns. Part of the reason may have to do with an old
"In on greed, out on fear." Although both greed and
Wall Street saying,
fear are strong emotions, I think many would agree that of the two, fear
is the one that could cause the most volatile markets. During market
bottoms, traders or investors usually have the opportunity to wait for an
opportunity to enter the market. They may bide their time and wait for
a pullback or for the market to build a base, or to see how the market
"I want
reacts to news. Fear is more prevalent at tops. Fear is saying,
out-now!"
In Exhibit 3.25 we seethat an advancethat started in late 1991stalled
at the doji following the tall white candle. The extended upper shadow
in May echoed the importance of the resistancearea set by this doji. The
market then retreated until August's piercing pattern. The piercing pattern was also at a support area based on a 50o/oretracement of the rally
from the Decemberlow to the May high. The 50o/oretracementarea should
be closely monitored by traders because such retracements are widely
watched by technicians. This pattern became support that was held in
October with a high-wave candle. The rally from this base near $33 stalled
at another doji following a tall white candle in early 1993.
Exhibit 3.26 displays that April's piercing pattern confirmed a support
EXHIBIT 3.25. Piercing Pattern Confirms Support, Silver-]uly 1992
75
76
Candles
area provided by the prior week's hammer. Another piercing pattern in
late May and early ]une signaled a temporary base for another assaultat
May's resistancearea near $4.rs. A series of two hanging man lines
appeared at that resistance.Note how the first hanging man was not
confirmed (since the next session did not have a lower case). Only on
the day after the second hanging man session,with its close undei the
secondhanging man's real body, was the hanging man line confirmed.
The Engulfing Patterns
An engulfing pattern is a two candle pattern. A bullish engulfing pattern
(shown in Exhibit 3.27A) is formed when, during a downtre"d; ; white
real body wraps around a black real body. A bearish engulfing pattern
(Exhibit 3.278) is completed when, during a rally, a black real Lody envelops a white real body.
The engulfing pattern visually shows how the opposing forces had
gained control of the market. For example, a bullish engulfing pattern
reflectshow the bulls have wrested control of the market from the bears.
A bearish engulfing pattern shows how a superior force of supply has
overwhelmed the bulls. The ]apanesesay that with a bearish engulfing
pattern, "the bulls are immobilized." we previously saw how with the
dark cloud cover, the bears were able to move prices into the prior white
real body, but with the bearish engulfing patterns, the powut of the bears
was such that they were able to pull the close under the entire prior
white real body. The same concept can be used to compare a pieicing
pattern to a bullish engulfing pattern. With the piercing pattern, the bulls
counterattackstrongly enough to push the closeof the secondwhite real
body well into the prior black real body. However, with the bullish engulfing pattern, the bulls' strength is that much greater since the close
of the white candle sessionis above the top of the prior black real body.
Although this generally means that the bearish engulfing pattern is more
bearish than a dark cloud cover, and a bullish engulfing pattern more
bullish than a piercing pattern, it is equally important to seewhere these
patterns emerge before deciding which is more important. For instance,
a piercing pattern that confirms a major support area should be viewed
more likely as a bottom reversal signal than a bullish engulfing pattern
that does not confirm support. This vital aspect of viewing the candle
patternsin conjunction with the overall technicalpicture will be discussed
in depth in the next chapter.
The basic definition of an engulfing pattern is that the second real
body must engulf an opposite color real body. However, not all engulfing
patterns are equally important. The importance of the engulfing pattern
The Patterns
ffi
il rI
(A)BullishEngulfing
Pattern
+
rl
/ \
EXHIBIT 3.27. Bullish
and Bearish Engulfing
(B) BearishEngulfingPattern
Patterns
is dependent on the relative size of the real bodies, the relationship of
the shadows to one another, and other factors. For example,the strictest
definition of an engulfing pattern would be if the first candle is small and
the second candle very large, and the second real body wraPs around
the entire first candle-including its shadows. The next strictest definition
would be if the shadows of the second candle exceededthe shadows of
the first candle (in other words, on the second day of the engulfing
pattern, the market made a higher high and a lower low).
77
78
As with a dark cloud cover, if the market surpassesan engulfing
pattern, it is said to go opposite to the pattern. This means that if prices
closeabove the top of the bearish engulfing pattern (including the upper
shadows), the outlook turns from bearish to bullish.
Aspects addressedin this section's charts include:
1,. how engulfing patterns become support and resistance;
2. how an engulfing pattern can be combined with Western technical
tools;
3. why traders should be more flexible in defining an engulfing pattern
with stocks compared to futures;
4. the importance of comparing the size of the two real bodies of the
engulfing pattern;
5. the danger signal of a bearish engulfing pattern after a doji.
In Exhibit 3.28, the first sign of trouble was with the high-wave candle
in late August. During the first two sessionsof September,more trouble
arosewith a bearish engulfing pattern. The market backedoff from there,
and found support at the mid-August rising gap. (we will look at how
gaps become support or resistancelater in this chapter.) The rally from
EXHIBIT 3.28. BearishEngulfing Pattern as Resistance,December1993s&p
The Patterns
79
this gap stalled at the resistancearea set up by the bearish engulfing
pattern.
Exhibit 3.28 also displays how the candles can offer reversal signals
not availableto those using Western technical tools. With Western technicals, there is a reversal signal called a top outside reversal session,
sometimesalso known as a key reversal. This occurs when prices make
a new high for the move and then closelower than the previous session's
close. Note how in the bearish engulfing pattern highlighted in the
S & P was not a reversal sessionsince the second sessionof this bearish
engulfing pattern (i.e., the black candle) failed to make a new high for
the move. Yet, becausethe black candle enveloped the white candle, it
was a bearish engulfing pattern. Consequently,while no reversalpattern
was revealed with western technicals,there was a reversal with candle
charts.
In Exhibit 3.29, we see how a selloff in Decembercommenced with
the doji following the tall white candle. This area's resistancewas con-
COCA-COLA- DAILY
']*u
t--^\
446
44n
4?6
+2,5
+1.5
+1.0
+0.5
+0.D
+3.5
'l,,iool,ilolilt*,r\
il0,'l,,oil
r+tl
il
t t [
fliil
T+hlilt,
+3.0
+3.D
+2.0
++.5
++.
D
Long
I
I Upper
I Shadows r
+2.5
+2.0
+1.5
+1.0
+0.5
+0.0
fu{"r*tl
Bullish
Engutfing
Pattern
?qE
?qn
92
D7 t+
28 q? 1t 18 TJ
08 t5 22
Metastockby EQUIS Int'l
EXHIBIT 3.29. Bullish Engulfing Pattern as Support, Coca Cola-Daily
39.5
39.0
08 15 22 29
80
Candles
firmed by the long upper shadow candle near g44 a few sessionslater..
The selloff found a base in ]anuary 1993near $40 via a bullish engulfing
pattern. From there, the market rallied, and again stalledvia a long upper
shadow candle near the previously discussedresistancearea of g44Basedon the action describedthus far, we know that $44 is resistance
and the bullish engulfing pattern near g40 is support. Thus, for traders
looking for a buying zone, it could be done on correctionsto the bullish
engulfing pattern (near $40) with a target towards $44 and a stop on a
close under the lows of the bullish engulfing pattern. This scenuiio ,rr.rfolded in February. The concept of risk-reward is very important. Before
placing a trade with candlesor any other form of technicaianalysis,riskreward must always be considered(in Chapter 4, I will discusstiris critical
subject in more depth).
Exhibit 3.30 displays a classicbearish engulfing pattern near g50. It
was classicsince a very tall black real body enveloped a very short white
real body. In March, there was another bearish engulfing pattern. This
DtLL
50
19
4B
17
ril
1D
17
BearishEngulfing
Patterns
\
+1
13
il1ili+*+
onotT*t,;OillFfi
I
A /
45
+1
13
47
11
40
39
3B
50
19
18
47
15
15
ilil'
im,
iilr1'['
4?
\
-11
10
39
38
37
36
35
l"l^
'1,,0*ilit,,fil'uloi*,g
i** :il|
^/
JD
35
31
3+
,rilrro*Ll,''Yr+in;i
JJ
33
JI
JI
a1
JI
30
29
' 9 21 1
fl'
T
21 28 r$
1l
18 25
T!
0B 16 22
MetaStockSoftware by EQUIS
EXHIBIT 3.30. Engulfing Pattern confirms Retracement, Dell-Daily
30
29
la
0B 15 22 29A
12
ThePatterns
81
one confirmed a resistancearea defined by a 50o/oretracement of the
selloff from A to B.
Becausestocks often open relatively unchanged from the prior close
(as compared to the futures market), there should be more flexibility in
defining an engulfing pattern with stocks than with the more volatile
futures markets. Specifically, I still view it as an engulfing pattern if the
open of the second sessionof the candle pattern is the same as the close
of the first candle. This is shown in Exhibit 3.31.
Exhibit 3.32 shows an example of a bullish engulfing pattern in which
the open and the close were about the same. The importance of this
pattern was reinforced by the fact that it becamesupport during the April
L993pullback.
When looking at an engulfing pattern, you should consider the relative sizes of the real bodies that form the pattern. An ideal bearish engulfing pattern has a very large real body enveloping a small white real
body. The diminutive size of the first small body of a bearish engulfing
pattern shows that the momentum of the prior rally is slackening. The
large black real body after this small candle then proves that the bears
have overwhelmed the bulls.
However, if there are two almost equal size candles that comprise the
engulfing pattern, the market may move into a lateral band, rather than
reverse(this concept may be useful for options traders who are looking
to sell volatility). I will use Exhibit 3.33 to illustrate this important concept. In this deutschemark chart, there was a bearish engulfing pattern
in ]uly 1992(1.on the chart). Note how the white and black candleswere
about equal in height. The fact that they are about equal means that the
bears and the bulls are about equally strong. With no clear-cut victory of
the bearsover the bulls, it should not have been unexpectedto seeprices
move sideways for a few weeks. On a breakout from this engulfing pat-
"[
r l"
I
|"l Ll"
.-''
BullishEngulfing
Pailern
EXHIBIT 3.31. Engulfing Patterns Where
BearishEnoutfino
Patteri
Open and Close are the Same
82
Candles
GAP_WEEKLY
t+
++
t3
+2
+1
+0
+3
+2
+1
+0
39
38
37
35
35
JJ
38
37
35
?6
31
33
32
3+
JJ
?r
30
fJ
a
27
,92 JUi{ruL ilJ6 StP
OCI NilJ DIC '93 FtB I1RR
RPRI1AYJUNruL ilJD
32
3l
30
29
28
27
MetaStockby EQUIS Int'l
EXHIBII 3.32. Engulfing Pattern and Stocks, Gap-Weekly
tern's resistanceband, the market stalled at another bearish engulfing
pattern at 2.
The bearish engulfing pattern at 2 was more significant with its small
white real body and massiveblack real body. It was thus more likely to
Presagea price turn rather than a move into a lateral environment. This
engulfing pattern then became a resistance area.
Exhibit 3.34 displays a bearish engulfing pattern in early 1ggr. Note
how the white and black candles were about equal. As just discussed,
this could mean a period of consolidation;this is what unfolded as prices
moved into a lateral trading band. The highs of this bearish engulfing
pattern set up a resistance area that was confirmed by a long upper
shadow. Another bearish engulfing pattern appeared in octobet iggz.
Becausethe october bearish engulfing pattern had a very large black real
body and a small white one, it was more important than the prior engulfing pattern. Even more portentous with the october engulfing pattern was that it followed a doji. Specifically, if there is a bearish engulfing
pattern that follows a doji, it is viewed as being a particularly bearish
combination.
ThePatterns 83
EXHIBIT 3.33. Engulfing Patterns and Size of the Real Bodies, Deutsche MarkWeekly
O= 20967
H=,21241
L= 20638
L= 2O958
A= -56
EXHIBIT 3.34. Bearish Engulfing Pattern Following a Doji, Nikkei-weekly
U
C-andles
Last Engulfing Patterns
A bearish engulfing pattern is a large black candle that envelops a small
white real body after an uptrend. However, if a bearish engulfing pattern
appears duing a pricedecline,it has the potential of being a bullish bottom
reversal signal. This pattern is known as a lastengulfingbottom(seeExhibit
3.35(A)).The last engulfing pattern is viewed as a turning point for the
bulls if prices can close above the black candle's close.
A bullish engulfing pattern is a two-candlestick Pattern inw}":rich,during a downtrend,a large white candle wraps around a prior small black
real body. However, if, during a rising market,a large white candle engulfs
the previous day's black candle, it is a potentially bearish pattern, referred to as a last engulfing top (Exhibit 3.35(8)). In candle theory, the
bearishnessof this pattern is confirmed if the next day the market closes
under the prior white candle's close.
In Exhibit 3.35(8), the merged candle of the last engulfing top looks
bullish with its long upper shadow. However, remember that the last
engulfing top appears in an uptrend, so the merged candle line can be
compared to a potentially bearish hanging man line.
The |apanese colorfully compare the last engulfing pattern top to dou-
{
(A)
+
+l
(B)
EXHIBIT 3.35.
Last Engulfing Bottom and Top
,r\
The Patterns
85
ble lovers' suicide. This is becauseyou fall in love with the market (because of the last engulfing pattern's long white candle), but both you
and the market perish together. Thesewords might be a little strong, but
they convey the cautionary approach traders should take after the emergenceof a last engulfing pattern.
In April 1992, in Exhibit 3.36, there was a bullish engulfing pattern
(note how, becausethis was a stock, I still viewed it as a bullish engulfing
pattern although the second session's open was the same as the prior
close).The rally from that pattern stalled at the last engulfing top. Note
how both of these patterns just discussedhad a white candle enveloping
a black real body. But what was the difference? In the regular bullish
engulfing pattern in April 1992,the combination of the white enveloping
the black candles surfaced during a downtrend. In August 1992,the same
combination of candles appeared after an uptrend, thus beco-i.g a last
engulfing pattern top. The fact that the next day's sessionclosed under
the long white real body's close was confirmation of the last engulfing
toP.
EASTMANKODAK-WEEKLY
51
50
50
+9
+B
+7
+6
+5
++
+3
+2
+1
+0
39
19
I
3B
'92 ttB
+B
+7
+5
+5
LastEngulfing
++
+3
+2
+1
+0
?q
Bullish /TV\T
Ensullins\|,
I
fthR ApR flRY
3B
JUN Jr.[-
AIS StP OCT NDU DTD
MetaStockby EQUIS Int'l
EXHIBIT 3.35. Last Engulfing Top, Eastman Kodak-Weekly
93
86
Candles
EXHIBIT 3.37. Last Engulfing Bottom, fune 1993Bonds-Daily
In Exhibit 3.37, a bearish engulfing pattern aroseat April's price peak.
Prices then descended,finding support at the bottom of the tall white
candle.This support was testedin late April with a black candlewrapping
around a white real body. This had the shape of a bearish engulfing
pattern, but it appearedduring a downtrend. As such, it becamea bullish
last engulfing bottom.
In Exhibit 3.38, at the September lows, there was a last engulfing
bottom. One of the more interesting aspects of this chart is that the
volume on the long black candle sessionwas unusually high. This could
be viewed as a selling climax. This increased the chance that the last
engulfing pattern was a bottom reversal.
Harami
The harami is comprised of a long real body and a small real body within
its range. The harami is the reverse of an engulfing line. Whereasin an
engulfing pattern there is a long candle engulfing the previous real body,
a harami is an unusually long real body followed by a very small real
body.
After a downtrend, the emergenceof a harami shows, as expressed
in Japan, that "the decline is exhausting itself." A harami, after an ad-
ThePatterns
EXHIBIT 3.38. Last Engulfing Pattern and Volume, December 1993 Gas Oil
vance/shows that the market must have failed to maintain higher prices.
As shown in Exhibit 3.39(,4,),either candle of the harami can be white
or black; all combinations are called harami. However, after a downtrend,
a white-black (meaning the first candle is white and the secondis black)
or a white-white harami is viewed more bullishly than a black-white or
a black-black harami. This is because a long white candle is by itself
riewed as bullish, so its appearancein a harami increasesthe chancethat
the falling power of the market will come to an end.
The samerationale applies to a harami after an uptrend. As displayed
in Exhibit 3.39(8), a harami with a long black real body can be viewed as
more bearish than a harami in an uptrend that has a long white real
body. This is becausea long black real body after a rally is construed as
bearish, so when it is the first part of the harami pattern, the degree of
pessimismis increased.
Other aspectsthat will increasethe importance of a harami include
the following.
t. If the second real body is in the middle of the trading range of the
first real body. If, after a rally, the second real body of the harami is
near the upper end of the first real body, the odds increasethat the
87
88
C.andles
r.--l-
L F I,
I
fil
_____-_-_!
E itherLinecan be
Whiteor Black
(A)
t
l+
Y
\ ,
EitherCandlecan
be White or Black
EXHIBIT 3.39. Harami
market will consolidate rather than reverse. I refer to such a harami
as a high-priceharamlsince the second session'sprice is in the upper
end of the prior range. In a downtrend, if there is a harami with the
second small real body near the bottom end of the trading range of
the prior long real body, then the outlook is more likely for a market
lull rather than for a price reversal. I call this type of harami pattern
a lout-pice harami.
If the entire range, that is, the open, high, low, and close, are within
the prior real body, the chancesincreasefor a price reversal.
The smaller the shadows and the shorter the real body of the second
candle, the better the signal. If the second candle is a doji instead of
a small real body, it increasesthe probability of a reversal. This combination of a long candle followed by a doji in the first candle's real
body is called a harnmicross.
The Patterns
89
Some fapanese literature refers to harami as transition periods in the
market. This means that if a harami in an uptrend is exceeded, it is
viewed as a bullish continuation signal. If the price closesunder the low
of the harami sessionin a downtrend, then expectmore selling pressure.
Exhibit 3.40 illustrates how a rally that started with November's
bullish engulfing pattern hesitated at a harami in December. This harami
had two aspectsthat increasedits reliability: the second day's small real
body was almost in the middle of the first real body, and the entire range
of the second session(including the shadows) was within the real body
of the first session. It is interesting how the same scenario unfolded in
February. Again, a rally began from a bullish engulfing pattern, and then
again stalled with a classic harami. With the harami, as the japanese
would say, "a crack has entered the market." A shooting star a few
sessionsafter the February harami was also a bearish upthrust in which
the market made a new high, but the bulls failed to hold these highs.
(Although the shooting star sessionhad a real body within the prior long
DOWCHEMICAL_DAILY
s.5
a0
59.5
59.0
58.5
58.D
52.5
58.5
5&D
y.5
Harami
v.D
56.5
55.0
55.0
545
55.0
5+.5
5+.D
535
53.0
525
520
51.
5
51.0
505
50.0
s.5
s,0
E4E
5+.0
53.5
530
52.5
52.D
"'"1/',,r*,
Ir
6't E
5 10.
50.5
50.0
+$5
'92
fr,0
K5
4aq
DTD
93
FE
nftR
MetaStockby EQUIS Int'l
D(HIBIT 3.40. Harami, Dow Chemical-Daily
hPR
ilhY
90
Candles
white candle, these two candlesdid not form a harami becausethe upper
shadow of the shooting star was too far outside the prior session'srange.)
If there was any doubt about the serious trouble this market was in,
the falling gap at the arrow should have been the final proof. Note how
the harami sessionsin December and February becamea ceiling. The low
in this market was made via a hammer in April. Later that month, a
violently long white real body was immediately followed by a diminutive
real body. This formed a harami that precipitated a decline until the
emergenceof another hammer.
In the chart shown by Exhibit 3.41, the selloff from a bearish engulfing
pattern found a foundation with May's harami. This second candle of
the harami hovered near the bottom of the prior long black real body.
As a result, there was more likelihood that prices would move sideways
near the lower end of the tall black candle's real body. Note that the long
lower shadows after this harami reflected healthy buying interest as prices
GENERALRE - WEEKLY
lm
IDD
atr
90
85
fii***'
lt'ot*
t frrr*41d-il+l*u,nil
80
'91 stp oDI hffiJ DEC,92
105
100
qE
90
85
80
FTB IfiR hPR NAY Jr,htJr.[- flJ6 stp DDI
Metastockby EQUIS lnt'l
EXHIBIT 3.41. Harami, General Re-Weekly
The Patterns
EXHIBIT 3.42. Harami and the Size of the Second Real Body, November 1992
Heating Oil
got near $80. The pattern marked X was not a harami becausethe white
real body was not unusually long. For a harami, the first real body has
to be very long relative to the precedingbodies. Another harami appeared
in early August, but after an initial setback, prices exceededthe harami
so the trend resumed higher.
Exhibit 3.42 shows two examplesof harami in which the open, high,
low, and closeof the secondreal body are within the first real body. The
October harami pattern was more important because of the extremely
short real body. Its small size made it like a doji session.Thus, October's
harami could be viewed as a harami cross. The seriesof three long black
real bodies (labeled1.,2, and 3) following October's harami underscored
the inherent weaknessof the market.
In Exhibit 3.43, in February 1992,we see how a support area (which
included a hammer) formed within a $19.00-$19.50area. Based on the
axiom that old support becomes resistance (the change of polarity principle), we would expect$19.00-$19.50to becomeresistance.That is what
developedas this resistancewas first confirmed by a shooting star. From
there, the market descendeduntil the piercing pattern occurred. Another
assaultat the $19.00-$19.50resistancearea materialized in Muy. At that
time, a harami pattern was followed by a dark cloud cover. Another failed
91
92
AST_ DAILY
n"0
2.5
22,0
21.5
rr,illr,*il'l/!il"ri10
irntiu,
'ffiiil.
rrr
;il'l!fi.''oi
'u
lil'TT'l+llil'
a.D
2r.0
205
20.5
20.0
19.5
19.0
18.5
18.
0
n0
/";{ffi"ud cover
.,,SLTt"n
19.5
SupportZone
1 9.
0
1 8.
5
Hammer
18.0
t7.5
t7.0
1 5.
5
15.0
1 55.
1 50.
Zone
Resistance
Aa-',
t7 E
l*[ll,*il*++o
I
o
r+.5
l'-
l.
t46
P iercing
Pattern
t 4n
'92 10 t82+
l/.0
15.
5
15.
0
15.
5
15.0
na
Ib
05 l 3 2D 27
1+.0
t l 1B 25
D8 15
MetaStockby EQUISInt'l
EXHIBIT 3.43. Harami Confirming a ResistanceZone, AST-Daily
attack at the resistancein late May occurred via a long upper shadow
candle (this candle was not a shooting star becauseit did not appear after
a rally).
As discussedbefore, the ideal harami pattern has the secondsession's
real body in the middle part of the first candle. However, if during an
uptrend the second candle hovers near the top of the prior candle (i.e.,
a high-price harami), the chancesincreasefor a consolidation rather than
a price reversal. In Exhibit 3.M, we see how several high-price harami
(marked 1 through 3) developed from early |une through late ]uly. After
each of these, the market consolidatedfor at least a week before moving
out of the trading range. This chart brings out another use of a high-price
harami (or a low-price harami in a downtrend)-option traders can consider selling volatility. This is because after a high-price harami in an
uptrend or a low-price harami in a downtrend, a trader could expect that
the market posture may temporarily settle into a lateral band from a
previously strong trend. This could mean a decline in volatility.
The Patterns
EXHIBIT 3.44. Harami with Second Candle Near Top of Prior Candle, September
1993Bonds
THE WINDOW
The window, also known as disjointed candles,is one of the more powerful candlestickpatterns. As shown in Exhibit 3.45(A)and (B), a window
is the same as a gap in the West. That is, for a rising window, the top
of yesterday's upper shadow should be under the low of the today's
lower shadow. A falling window means that the low of yesterday's session (i.e., the bottom of the lower shadow) is above the top of today's
upper shadow. Windows are a good visual clue because they clearly
display that the action and market sentiment is so one-sided.
In a talk I gave before a group of traders, I mentioned how, based on
my experiences,the window was a candle tool that I have found to work
well. After I mentioned this, a trader in the audience told me that he
used to work at a Japanesebank. After my explanationof the importance
of windows, he said that he then understood why the )apanesetraders
at the bank would routinely go to the charts looking for gaps-sometimes
even going back years to find one. This comment reinforced what I have
found to be true about the windows-it is a candle technique not to be
ignored.
93
94
Candles
r l t t l
Uppershadowof (1)
doesnottouchlower
shadowof (2)
l#__,_Hl"#.,?i
\_________{g_
Ft';-------1-
f
Bottomof
window
Close above bottom
of window keeps
uplrend intact
I
(A) RisingWindow
I
ropof
window
Lowershadowof (1)
doesnottouchupper
shadowof (2)
Closeundertop
ol windowkeeps
I
I
lt+
alT
(B)Fallingwindow
EXHIBIT 3.45. Rising and Falling windows
Windows are continuation patterns in which the market resumesthe
trend taken before the continuation pattern emerged. Thus, after a rising
window, which is a bullish continuation pattern, the prior uptrend should
continue. A falling window has bearish implications since it means the
prior trend, in that casedown, should resume.
There is a saying used in Japan about windows, "The reaction will
go until the window." In other words, the window should be the limit
on a reaction. Thus, for a rising window, reactions(i.e., selloffs) should
stop within the window. For a falling window, rebounds (i.e., rallies)
should stop within the window.
when using windows as support and resistance,it should be noted
that the price may fall below the bottom of a rising window or above the
top of a falling window temporarily before prices move back in the direction of the window. This is illustrated in Exhibit 3.45(A) and (B).
A general rule that I have found useful based on my experienceis
that if the price closesthrough the window, I then view the prior trend
as being voided. For example, if there is a rising window between g83
and $85 and then the market closes under the bottom of the window
(i.e., under $83), the uptrend can be considered as over. Conversely, if
there is a falling window between $62 and $60, once the bulls close the
The Patterns
market above the top of this window (at $62),then the bulls have broken
the back of the bear market.
Basedon the discussion above, an intra-sessionmove under a rising
window (or above a falling window) is not proof of a break. The consequence of this is that you should wait for the market to close under the
bottom of a rising window (or above the top of a falling window) to
confirm that the uptrend is over (or that the downtrend has been voided).
On a weekly chart, you should wait for a weekly (that is, a Friday) close
under the bottom of the window to say that a window's support had
been broken. The risk in waiting for a close to confirm the break of a
window is that, by the time this happens, the market may be sharply
higher or lower than you may have wanted to risk.
In this section, I will discuss:
1 . waiting for a closing price to confirm the break of a window's support
or resistancearea;
2 . how volume can influence the importance of a window;
3 . using windows to confirm a trend reversal;
4 . how windows can provide a quick clue to the market's health;
J.
waiting for three sessionsfor confirmation of a window;
EXHIBIT 3.45. Intra-Session Break of a Window, December 1993 S&P
95
96
Candles
6. three windows and confirmation of a trend reversal;
7. two black gapping candles;
8. gapping doji.
Exhibit 3.45 shows that a selloff from a bearish engulfing pattern held
August's rising window as support. The long lower shadow of candle 1
and the tall white real body of candle 2 echoed the importance of this
support area. Candle 1 pulled under the window on an intra-day basis,
but by the close,the bulls had managed to push prices above the bottom
of the window. This left the uptrend intact.
Exhibit 3.47 shows that there was a rally that started with the October
5 hammer. The force behind the bulls' move was echoedlater that month
by the rising window and its accompanying high volume (seethe arrow).
ItVhena window opens via a tall white real body, it has the nickname of
a running window (basedon the fact that the market is "running" in the
direction of the window). The rally from this window hesitatedvia a doji
APPLE-
DAILY
59
5S
lm;il*r-
58
58
57
56
55
54
53
52
5l
57
56
55
51
53
5?
51
50
4S
.18
ntltfr
utt ttl+lt[],
47
16
50
4S
48
47
16
*,"'nn
wnoow
.l
,,, ,T++rlrfh*Jf,*
,
45
45
11
11
13
43
42
1L
40
3S
42
Hammer-
4t
40
3S
'g2 oB
L4
28
005
L2
t9
EXHIBIT 3.47. Windows and Volume, Apple_Daily
09
23
The Patterns
after the tall white candle. The fact that the pullback from this doji held
support at 50o/oof the white body (seethe dashed line) showed the Power
of the bulls to support the market. Note how, as the market ascended,
the midpoint of the tall white candles became support.
Exhibit 3.48 illustrates how fune's dark cloud cover short-circuited the
prior rally. The sell-off from this pattern found a floor at April's window.
Other aspectsof this chart are interesting. The low of |une's price decline
was a harami. This harami appeared within the support band, as Predicted by the window. This same combination of a harami within the
window also emerged in Muy. Notice how the fune rebound from the
window stalled at the resistance area set uP by the dark cloud cover.
A shooting star is potentially bearish, but what if the shooting star
sessionalso forms a rising window-which is bullish? In Exhibit 3.49, we
see that such a scenario unfolded as in mid-January. After the shooting
star line appeared, I was asked by a client whether this was a sell signal
(the client knew that a shooting star was normally a bearish signal). I
pointed out that while this was indeed a bearish shooting star, there was
another aspect that was perhaps even more important-the rising window. I suggested to this client that if he wanted to sell short, he should
wait for the market to close under the bottom of the window to confirm
that the uptrend was over. Since the bears could not pulI prices under
EXHIBIT 3.48. Window as Support, September 1993fapanese Yen
97
98
&ndles
o
o
6
EXHIBIT 3.49. shooting star and a Rising window, March 1992silver
the window, a short salewas unwarranted. After the next session'srally,
the client, who did not go short, ordered ten copies of my first book to
give to his friends!
Exhibit 3.49demonstratesa critical concept sometimesforgotten, even
by practitioners of the candle charts. Namely, that an individual candle
pattern should be viewed in the context of the surrounding technical
picture. In this example, a shooting star viewed in isolation (that is, by
not looking at the window preceding it) could have caused a poorly
positioned trade.
when I show Exhibit 3.50 at my seminar, I title it, "saved by the
Light of the Candles!." This is becausethe chart is an example of how
candles can help avoid a bad trade. In mid-March, the market closed
above a major resistanceline that went back to December1991(only the
last part of this resistanceline is shown on the chart). This breakout action
could have been viewed as potentially bullish. However, there was still
a lack of confirmation based on the candles. Specifically, there was an
open window in early March that was yet unclosed. Based on candle
principles, until the market closesabove the top of the window (in this
case at $1088),the trend was still down. observe that, in spite of the
breakout from the resistanceline, the bulls could not push ihe market
high enough to close above the top of the window. so although a resis-
The Patterns
1.*'.iri
lrfi+,orflh.}
nfi"-4t*,,,i
tr 0r+r+
nfr+;
:
EXHIBIT 3.50. Window as Extra Confirmation, May 1992 Cocoa
tance line was pierced, those who knew about the candles were kept
from going prematurely long.
The window can be used as a potent confirmatory mechanism.If there
is a reversal signal followed by a window in the same direction, trade rs
should be more confident of a price reversal. Exhibit 3.51 is an examrple
of this aspect. There was a bearish engulfing pattern in May. Prices descended slightly, and then moved up to reach new highs in early I uly.
As this time, another bearish engulfing pattern appeared.However, urlike May's bearish engulfing pattern, July's was followed by a f alling
window. This window served to reinforce that a top had been 'put in
place.
Exhibit 3.52 shows how candles can help give a quick underst;anding
of the market's health (or illness). In this case,there was a stock rrhatone
of my friends had bought. Some very bullish news came out, and immediately after this news, the stock soaredto a new high (seethre 6so*;.
There were a few ominous signs that appeared in spite of this bullish
news. First was the fact that the day the market moved to a rnew high,
it finished the sessionby closing under the prior day's close.This formed
a dark cloud cover.
The other problem was more significant. As I explained to my friend,
a market that fails to hold new highs on supposedly bullisrh news is a
99
L00
Candles
IBM_ WEEKLY
ll,=,llll,,[il,
Fqli,,
'*l
,r{+ril*1
I
I
r
I
L
I
L' g z II t . t s
EXHIBIT 3.51. Windows as Confirmation, IBM-Weeklv
dar,rgerousmarket to be long. A stock's price is composed of the total of
all irrformation, whether the information is known by the general public
or b1'a selectfew. Many sharesof this stock were held by relatively few
peopi'e. The failure to hold the new highs probably meant that they knew
somet,hing the general public did not. They may have taken the opportunity to sell into the rally. of course, there was always a chance fo,
recover.yto the new highs. But, after I saw the falling window, I mentioned to my friend that until the market closed above the top of the
window, the market was in a downtrend. This window becameresistance
as showrr by the dual shooting stars. Notice that in August, another
falling r,vi.ndowopened.
Some ,Tapanesetraders believe that if a window is not filled within
three sessions, it is confirmation that the market should move in the
direction oI'the window. That is, if there is a falling window that is not
filled within: three sessions,the market action is viewed as confirming
that prices should move lower. In one of the books I had translated, it
said that if a window is not filled within three sessions,then there is
101
The Patterns
DAXRO- DAILY
L7.g
16.5
15.0
15.5
15.0
14.5
14.0
13.5
13.0
12.5
L2.O
1t.5
11.0
l
t5.5
15.0
14.5
t4.0
-""ils
s'""
lf,/*
,,,4,oiltu
'1"
t? 6
13.0
12.5
12.tr
t l n
r.1.0
| ,\',,
,il*1oil'
illtr-"--
rn F
10.0
9.5
tn E
10.0
s.5
lil"u
9.0
8.5
4lilrndl,xor' oto't,,*,,01,*0,ilh1
il"
lil
l**,,il,,.
o n
8.5
8.0
7.5
? n
8.0
7.5
7.9
E 6
5.5
6.0
5.5
5.0
4.5
4.0
'92
L7.O
16.5
16.0
5.0
5.5
5.0
4.5
4 n
t5
13
t0
t4
28
EXHIBIT 3.52. Windows as a Mechanism for Quickly Analyzing the Market,
Daxro-Daily
power to go thirteen more sessionsin the direction of the gaP. I do not
agree with the precisenessof the last part of that statement, but this
technique of waiting three sessions for confirmation may Plovide a
method to confirm a window's support or resistance.
In Exhibit 3.53, there was a falling window that opened in early March.
Basedon the abovediscussion,a method to trade with this window could
be to wait three sessionsand see if within that time the market can close
abovethe top of the window. If the bulls cannot push prices (on a close)
above the top of the window, candle theory states that this should increasethe chance that the downtrend will continue. After all, the bulls
had three sessionsto move prices through the window and failed to do
so. In this example, we see how the falling window acted as resistance
as the bulls tried in the third sessionto unsuccessfullypush prices above
the window. Attempts in May at this window's resistancelevel at 624
stalled via a dark cloud cover and then a long uPPer shadow candle (at
the arrow) a few sessionslater.
102
Candles
EXHIBIT 3.53. windows and waiting Three sessions,June 1993unleaded Gas
I would be careful about putting too much emphasison three sessions.
The Japaneseplace much importance on the number three in their culture, and this has spilled into their technical analysis.Thus, look closely
at what happens when you get a window in your market. you may find
that if the window is not filled in within two, four, or even five sessions,
rather than the more traditional three sessions,it could be proof of continuation of the trend predicted by the window.
Three Windows
As discussedabove, the Japaneseemphasizethe number three. In this
context, the Japaneseview a market that has had three rising or falling
windows in a row as a market that has reachedmaturity. The market in
such a scenariois viewed as being overextendedand correction is likely.
Three windows are shown in Exhibit 3.54.
Besidesthe windows, Exhibit 3.55 is of interest becauseit shows examples of many candle patterns. After a seriesof bottoming patterns in
Januarythat included a high-wave candle and the morning star, the market gave final bullish confirmation with a rising window. The market
ascendedstrongly from there until a harami pattern was formed. The
ThePatterns
iL
I
-L
Window 1 -----'-->
Window 2 +
window
t *---;----F-
ropwindow
lL,-
_
window.
I
-- La_I- I:f--
Ill
3 FallingWindows
ctosebelow
Window 2 '-"-+
Closeabove
Bottom
window
Window 3 --->
Ll_
-__t__
ir.-3 RisingWindows
EXHIBIT 3.54. Three Windows
correction from this harami stopped in mid-February with a successful
test of January's window. From the February lows until the dark cloud
cover in early March, there were three rising windows (numbered 1', 2,
and 3). The market then broke lower via a falling window. Note how
that falling window becameresistanceover the next few days.
As shown in the example above, if there is a bearish candle signal
after three windows, one should offset long positions. However, the
EXHIBIT 3.55. A Dark Cloud Cover After Three Windows, ]une 1993Crude Oil
103
104
Candles
more aggressive may be willing to, as the Japanesesay, "take a leap of
faith" and they can go short without a bearish candle clue of a turn.
It is my opinion, based on experience, that even if there are three
windows in the same direction, I would not trade against the direction
of these windows until I see more proof of a trend reversal. To me, this
would require that the market moves through the last window on a close
(as shown in Exhibit 3.54). Basedon this, bearish confirmation in Exhibit
3.55 came with the candle at x (in March), which closed under rising
window 3.
Exhibit 3.55 highlights how important it can be to wait for the top
window to be filled in before going short after three rising windows. This
gold chart shows a rising window in April that is labeled "window 2."
This is becauseprior to this date, and not shown here, there was another
rising window. This made April's window the second rising window.
Another window followed this, forming the third rising window. A few
sessionsafter window 3, there was a dark cloud cover that was completed
on May 3. This pattern signaled a change in the trend as the market went
from vertical to sideways. However, although the trend did change, there
was not yet confirmation that prices would descend becausethe bears
had yet to close the market under the top window (window 3). This
EXHIBIT 3.55. Waiting for Confirmation of a Trend Reversal After Three Rising
Windows, December 1993 Gold-Daily
The Patterns
window stayed open, and the market then continued on its upward
course. Interestingly, the same scenario as just discussed unfolded as
another dark cloud cover (dark cloud cover 2) formed after window 4.
After dark cloud cover 2, prices again went from an uptrend into a lateral
band. But the widow (number 4) remained unfilled on a close as it was
successfullydefended by the bulls via a hammer. Note how the window
was filled on an intra-day basis,but prices did not closeunder the bottom
of window 4. This meant that the major uptrend was still in effect. Consequently, I usually recommend our clients to use three or more rising
(or falling windows) at a time to offset or protect existing positions, but
not to go countertrend until the last window is filled in on a close.
Two Black Gapping Candles
\A/hile a falling window is bearish, it is even more portentous if the two
candlesimmediately following the window have black real bodies. Such
a combination is called two blackgappingcandles(Exhibit 3.57). The dual
black candles reinforce the fact that the trend has turned from up to
down. This pattern is a sign, as the fapaneseexpressit, of the "rout of
the bulls."
The chart of Delta in Exhibit 3.58 gave a plethora of signalsthat it was
experiencing trouble as it got in the $50 to $60 area. The topping signals
included:
1.. a bearish engulfing pattern;
2. a harami pattern;
3. an evening star;
4. a bearish engulfing pattern;
5. a bearish engulfing pattern;
6. long upper shadows, with the black candlefollowing the white candle,
forming a dark cloud cover, and for those knowledgeable about the
,
--L-------
--/
Falling
Window
EXHIBIT 3.57. Two Black Gapping Candles
105
106
Cnndles
DELTA_ DAILEY
60.0
59.5
59.0
58.5
58.0
57.5
57.0
55.5
56.0
55.5
55.0
54.5
54.0
53.5
53.0
,rqi"
il),a'"'"nwindow
1
6U.0
59.5
59.0
58.5
58.0
52.5
57.0
56.5
56.0
55.5
55.0
54.5
54.0
53.5
53.0
52.5
52.O
5t.5
5 1 .0
50.5
50.0
49.5
49.0
48.5
48.0
47.5
17.O
46.5
f,ffiqfitj*f'
,'lillpl"o
'ill
ltl
5t.5
52.0
51.5
5 1 0.
50.5
50.0
13.5
43.0
48.5
48.0
17.5
47.O
46.5
'g2 24
,O|1,
ilr,r*
rp'
ilo"o'
u\il
14
2T
L2
16
L1
EXHIBIT 3.58. Two Gapping Black Candles Confirm Resistance,Delta-Daily
candle patterns, the three black candles following the white candle,
forming a three-crow pattern.
The coup de grAcecame with two black gapping candlesin mid-November.
In Exhibit 3.59, December'sharami followed by a long black real body
was an important warning. Also note how those three candles (that is,
the two candles of the harami and the next candle) all had long upper
shadows. After this group of bearish signals, there was a falling window
with two black candles. This completed the two black gapping candles.
Gapping Doii
Exhibit 3.60 showr "d";i sessionthat gaps lower during a decline. It is
said this is a time where selling meets more selling and thus is a bearish
The Pntterns
r07
- DAILY
& JOHNSON
JOHNSON
55. 5
55. 0
54. 5
54. 0
53. 5
53. D
52.5
52. 0
5 1. 5
5 l. D
50. 5
50. o
49. 5
43. 0
48. 5
48. 0
47. 5
17. O
46. 5
16. D
45. 5
45. O
55. 5
55. 0
54. 5
54. 0
53. 5
53. O
52.5
52. D
5r.5
5 l. 0
50. 5
50. 0
49. 5
49. 0
48. 5
48. 0
17. 5
17. O
16.5
45. D
45. 5
45. O
Harami
$L-"."-
+u
+11**,n[r
*il
liff*.
'r
qfildt'il{rr**'*'fr
n\ililt'
ltf'
ilr'
U
'92
NOU
DEC
,33
Metastock
by EQUISInt'l
EXHIBIT 3.59. Two Black Gapping Candles, |ohnson and |ohnson-Daily
signal. I would recommend waiting for confirmation for this pattern on
the session after the doji. The reason for waiting is that if the session
after the doji is a long white candle that trades higher, it would turn out
to be bullish morning star pattern.
In my studies, I have seen reference to this gapping doji only in a
falling market, not to a gapping doii in a rising market. However, I see
no reason not to view such a pattern as being bullish since it has the
I
I
I
+-
Window
* ,
I
ExHIBIT 3.00. Gapping Doji
108
requisite rising window. In such a scenario,I would also prefer to wait
for a higher session on the day following the doji. This is becausethe
doji could be a sign of a tired market and if a white candle followed this
doji it would show that the market would then be refreshed.
As discussedin the section on doji, a doji after an uptrend or a tall
white candle could be potentially bearish. However, I would view the
fact that if a doji gaps higher, some of the potentially bearishimplications
of the doji are negatedbecausethe rising window shows the underlying
strength of the market.
As shown in Exhibit 3.61, the doji at session1 did not gap lower (that
is, the high of doji session 1 was above the low of the prior session).
Becauseof this, doji 1 is not a classicgapping doji, although the market
came so closeto opening a falling window with doji l that I still viewed
it as a gapping doji. Interestingly, the next session(at doji 2) the market
did form a gapping doji. A sign of further weakness arose when the
hammer and bullish engulfing pattern at 3 failed to hold as support when
prices closed under the support area set up by the bullish engulfing
pattern. At 4 the market gave an important bearish signal via the falling
window.
The gapping doji is a rare pattern, but in Exhibit 3.62 there is a falling
candle line with a small real body. While not a doji session,it could be
EXHIBIT 3.51. Gapping Doji, March 1994Notionnel Bond
109
ThePatterns
IBM- DAILY
56
56
55
55
,I
51
53
5{
53
- P,nl\+r
52
3t
3l
50
ill*,
19
tll
1B
5l
50
Ju,*
{9
ta ,l
1B
/ l.i,F++ Shootino
""'/*.ltl*lltt*l
B[T''n-,,l+ff.
16
17
15
11
33;''"n
h*,u,,,
, ,.^ilh+il
nrlil,ru,fiftl
lui Uf-o, -tiu++*
, 'll
, q+illl
12
11
,93 JUL
16
15
11
x"""'--*Tl
l, illttu
13
17
43
12
1i
sip
RUG
0cI
NOU
MetaStockby EQUIS Int'l
EXHIBIT 3.62. Gapping Doji, IBM-Daily
viewed as similar to a gapping doji in that the small real body is almost
a doji and it gapped under the prior lows. (Even if a trader did not view
this as a gapping doji, it could also be viewed as two black gapping
candles.) This chart has some interesting candle signals that illustrate
how IBM was basing out near $40. These include the long lower shadow
at candle L and a tall white real body at candle 2. A shooting star in late
August created problems on the rally from candle 2. The market broke
under the lows of the mid-September hammer, but it is interesting how
easily we can see the selling pressure evaporating during this sell off (at
X) by a series of gradually shrinking black real bodies. The long white
candle at Y showed that the bulls had taken control.
THREE OR MORE CANDLE LINES
The Evening Star
As shown in Exhibit 3.63, the evening star is a three-candlestick pattern.
The criteria for this pattern include an uptrending market in which a long
L10
Candles
Can be white or black.
lf this is a
doji, the patte
is an eveping
doji star.
(2)
t, l1
ilr
"[_
EXHIBIT 3.53. The Evening Star
white candle (candle 1 in the Exhibit) is followed by a small real body
(candle2). The small real body of the second candle line can be black or
white and should not touch the real body of candle 1. The third candle
of this pattern is a black real body that does not usually touch real body
2, and then closes well into the white candle line that make up the first
candle of this pattern. If the second candle of the evening star is a doji
instead of a small real body, then the pattern is an etsening
doji star.
In the Introduction to this book, I referred to the book written in the
mid-1700sentitled, TheFountainof Gold-TheThreeMonkeyRecordofMoney.
In that book, referenceis made to Yin and Yang markets. Yang is another
term for bullish (for example, a white candle is sometimesreferred to as
a yang line). A Yin move is a downturn. For instance,a black candle line
can be called a yin line. The Fountainof Gold has a section that reads,
"When movement reaches an extreme, there is stillness.
This stillness
gives rise to Yin." This is a verbal description of the evening star. To
wit!
"When yang movement reachesan extreme"-the appearance
of the
long white candle of the evening star pattern
2 . "There is stillness"-describes the small real body. The small real
body reflects a market at a transition phase in which the trend goes
from up to a period of "stillness."
3. "This stillness gives rise to Yin"-aptly describeshow the Yin (the
black candle) follows the stillness of the second candle line.
1.
ThePatterns 111
It is important to wait for the third line to get the bearish confirmation
of this pattern. This is because,after the secondcandleline, all we known
about the market is that it went from an uptrend to period in which the
bulls and bears were in a stalemateas gauged by the small real body of
this second candle. It is only after the long black candle moves into the
first session'swhite body that we get the proof that the bearshave taken
control of the market.
Exhibit 3.64 is an example of how an evening star confirmed a resistance area set up by a bearish engulfing pattern. Becausethis bearish
engulfing pattern and evening star arose near the same area, both patterns formed a potential double top near $45. In Western technicals, a
double top is confirmed by a move under the low between the two price
peaks that make up the double top. In this chart, this low was made in
A double top gives a measure derived on the range
February at $a012.
from the highs to the low of the pattern. In this case,there was about a
$5 range that is subtracted from the February low of $a01.This gave a
target to about ffi51. fhus, for those wanting to buy on price dips, a
HEINZ_ WEEKLY
466
46n
Bearish
Engulfing /1\
Pattern
|
|
ri$l
446
++.0
4?E
+3.0
+2.5
d.t
n
lL. U
+1.0
4nn
++.5
+1.0
+3.5
;il'I
._--[.
I
4ntr
ffi0
/Star
l1,q*
iT
ilLj
t l
41 6
4qE
Evenins
41 n
+25
+2,0
+1.
5
+1.
0
+0.5
'11{l**?iritr
39.D
38.5
38.0
37.5
32.D
*m::'
+u0
39.5
39.0
38.5
38.0
32.5
32.0
36.5
36.0
35.5
Jb. J
36.D
?65
JC. U
JD.U
?45
3+.5
' g Z DID
'93
FTB IlRR hR
IIRY JUN JUL
MetaStockby EQUIS Int'l
EXHIBIT
3.54.
Evening
Star Confirms
Resistance, Heinz-Weekly
fiUG
LT2
Candles
measuredmove target towards $3512
should be the area. We can seefrom
this example how smoothly candle charts can be merged with classic
Western charting methods (e.9., the double top).
In Exhibit 3.65, I illustrate that the evening star can becomeresistance.
As shown on this chart, November's evening star stopped the December
rally. I use the highest point of the three candles, that form the evening
star-that is, the top of the highest upper shadows, as my resistance.If
you can withstand the risk, I would recommend using a close (rather
than an intra-sessionmove) above the evening star's high as a buy stop.
In this case,it would require a weekly (that is, a Friday close)above the
dashedline to confirm a breakout from the evening star's resistancearea.
As previously discussed, there should be more flexibility in using
candles in the stock market than in some of the other markets, such as
futures. As shown in Exhibit 3.63, the classicevening star's three real
bodies should not be touching. However, becausein the stock market
the open price is usually near the prior session'sclose, the real bodies
may touch. In Exhibit3.66, we seehow the opening of the middle candle
PFIZER-WEEKLY
I
Ress'ance
BO
75
80
o**ilttol*;mrl
'f,?,,1
flllll-
70
75
70
' "l_rilrl.r
65
65
50
bU
55
55
JL
stp
ODT
N0u
DTD
,93
MetaStockby EQUIS lnt'l
EXHIBIT 3.55. Evening Star as Resistance,Pfizer-Weekly
FIB
r.lftR RPR
ThePatterns
113
WASTEMGMT- DAILY
EveningStar
35.0
35.0
35.'5
?66
l'lti,ht,l
35.0
3+.5
3+.0
<h tl
?46
3+,D
33.5
??6
33.0
32.5
33.0
32.0
32,D
?t 6
?l 6
3 10.
31,
0
30.5
30.5
30.0
30.0
29.5
,93
??6
26
l0
t 7 2+
D7 l +
tr-
IJ
L6
MetaStockbY EQUIS Int'l
EXHIBIT 3.55. Evening Star and Flexibility, Waste Management-Daily
of the pattern was about the sameprice as the prior session'sclose.While
some flexibility may be allowed with stocks in regard to the relation of
the real bodies, it should be remembered that the more ideal the pattern,
the greater the likelihood of a top.
The evening star from late August illustrated in Exhibit 3.67 is different from the more traditional evening star in that the third real body of
this one is a small black real body rather than a long black one. However,
I viewed this as an evening star variation with all the bearish implications
of the more traditional evening star for a few reasons, which I will now
address:
1 . The third candle of this evening star, although not a tall black candle,
nonethelessreflected the potency of the bears by the fact that they
were able to drag prices well into the white real body of this pattern.
2 . This evening star variation verified a resistance area. In mid-August,
there was a group of bearish candle signals that included a shooting
114
C-andles
EXHIBIT 3.67. Evening star and Flexibility, Natural Gas-september 1993
star, then three tall black real bodies #ter this shooting star, and then
a long upper shadow of the candle of August 24. Note how all these
bearish candles emerged near 92.50 This is the level where the variation of the evening star appeared.
Exhibit 3.68 shows a collapsing doji star. At a high-price level, the
market moves higher. After this, the market gaps lower via a falling doji.
This is a point where selling overwhelms buying. If the next session is a
fi
+ /window
|
t
EXHIBIT 3.68. The Collapsing Doji Star
I
*
f*ndow
l
ThePatterns 115
black candle that gaps lower, it is called a collapsingdoji star. The three
candlesthat make up this pattern are the same three as those needed for
the evening doji star. The differenceis that the evening doji star has the
doji above the tall white real body, while the collapsing doji star has the
doji gapping under, instead of above, the first white candle. This pattern
is said to be an "omen of a large decline."
While not an ideal version, candle lines A, B, and C in Exhibit 3.69
could be viewed as the collapsing doji star pattern. This chart shows the
three main conditions needed for the collapsing doji star pattern: 1) an
uptrend to reverse (at the white candle at A), 2) a doji sessionthat gaps
under the prior session (at B), and 3) another black candle that moves
under the doji session(at C).
Candle lines D and E show a gapping doji pattern (discussedin the
sectionon windows). While similar in appearanceto the collapsing doji
star, the gapping doji is a bearish continuation pattern. This means that
it occurs during a downtrend, while the collapsing doji star is a top
reversalpattern that occurs after an uptrend.
GAP -
59
58
57
56
55
54
53
52
51
50
49
4B
47
16
45
DAILY
59
5B
57
56
55
51
53
52
5l
50
19
4B
47
16
45
44
13
42
1l
{0
39
,,0*ilofi*o"lro,r/1i,,
do,il,r*..
c1
]J
42
1l
10
39
MetaStockbY EQUIS Int'l
EXHIBIT 3.69. Collapsing Doji Star, Gap-Daily
115
C-andles
I P\ r /
EXHIBIT 3.70. The
Morning Star
Ganbe whiteor black.
lf this is a doji,the pattern
is a morningdoiistar.
DISNEY-WEEKLY
+8
+7
+B
+7
+6
+5
*
+5
++
+3
+2
++
fl
+1
+0
+3
+2
+D
39
38
37
%
39
3B
37
s
35
3+
3+
<A
33
,92
JI.I,] JUL flF sp
ODT NsJ DtD ,93 FIB l1ARAm
Metastockby EQUISInt'l
EXHIBIT 3.71.
Moming
Star Confirms Support, Disney-Weekly
ilAY JUN
117
The Patterns
The Morning Star
Exhibit 3.70 shows that the classic morning star has none of the three
real bodies that make up the pattern touching. We can see from the
blended candle in Exhibit 3.70 that the more that real body 3 pushes into
real body 1, the longer the blended candle's lowet shadow, and hence
the more bullish the pattern.
As shown in Exhibit 3.7'1,,the area in which August's piercing pattern
appeared became support again in October via a classic morning star.
Also, the middle candle of this morning star was a high-wave candle.
The three candles highlighted in Exhibit 3.72 at the August lows created a morning star. When, as in this case,the star portion of this pattern
is a doji, the pattern is referred to as a morning doji star. There is another
interesting aspect about this morning star. If there is a doji session that
has a gap before and after it, is called anabandonedbaby.Inthis chart of
Penney, note how there was a gap between sessions 2 and 3 of the
morning star and almost a gap between the first two sessions.Thus, this
JCPENNEY- DAILY
78
77
7'6
75
7+
73
72
7l
r
tlr
78
r
,,,1['t'
76
a1
((
7q
7+
73
72
++ild+r?hl
iH
+l
tlot'u
t
ril ll, ^[l ., ..q*il*Jr+1,il
|n
l+ilfl
, ;1tr,il1t,,00'\,rn[ou*rr+r,il
Y'
7l
ZO
70
59
59
5B
67
bb
55
58
Tl
ilL,
/l,Yr
\l/
' 9 2 A t D v ? +s 0 8 1 + 2 2 8 0 t 2 l 9 2 6 N
Metastock by EQUIS Int'l
EXHIBIT 3.72. Morning Star, ]CPenney-Daily
67
55
65
118
Candles
was almost a very rare abandoned baby pattern. The abandoned baby
bottom is, in terms of a bar chart, an island bottom that is also a doji.
You can image how rare this combination is.
In the next chapter, I will focus on weighing the overall technical
picture in relation to an individual candle pattern. In Exhibit 3.73, I will
briefly addressthis issue. The hammer is September(at hammer L) was
a potentially bullish signal. However, this bullishness was mitigated by
the fact that on the day of the hammer, the market opened a falling
window. Note how this window then became a resistancearea. A few
sessionslater, another hammer formed (shown at hammer 2). The session
after hammer 2 completed the third line needed for the morning star
pattern. So, although there were two hammers in this chart, the overall
technical picture for hammer 2 was more consecutive than it was for
hammer 1 because of hammer 2's longer lower shadow and because
hammer 2 was part of a morning star pattern. As a result, for those
looking to buy, the areato have consideredwould be after the completion
of the morning star. Traderswho neededmore bullish confirmation could
APPLE_ DAILY
5S
5S
58
tn
5B
+rlll
ltl
57
I , I. n -
57
56
I'
55
55
55
54
54
53
53
52
52
ll''
51
50
49
48
nilr*l
--r
46
50
49
^,-^ah^
^ flt+f+fl]
4B
Closeabove | |
FallingWindow
||
lf$,Htt,
ffli'ls-
47
5l
47
\1.Lfiiillg-
46
'l-il1+,rT"
_i++
"",",'",.,
q}H:::;"'
45
44
43
42
'92 oB
EXHIBIT 3.73.
L4
2l
Morning
Star and Overall Technical Picture, Apple-Daily
28
005
L2
1,9
45
44
43
42
09
tb
ThePatterns
have waited until a closeabove the falling window's resistanceareafrom
mid-october. The rising window in mid-october gave even more bullish
proof.
In Exhibit 3.74, there was a hint of a bottom near $12 based on the
lune L992bullish engulfing pattern. In late ]uly, the support area of this
pattern (i.e., the lows of the bullish engulfing pattern it $fZ) was suc_
cessfullydefended. However, in August, these ib-, *"r" breached,but
only temporarily as the bulls were able to regain control of the market
by pulling prices back up over g12 again. In d&ng so, the market formed
a morning star pattern and a spring.
As shown in Exhibit 3.75, the first candle of a classicmorning star has
a large black real body. The third candle of the pattern is a tall white real
body that pushes well into the first candle of the pattern. In the morning
star pattern M1, the first candle had a small white real body instead of a
long lack real body. At patterns M2, the third candle (at the arrow) was
a small white real body instead of the more traditional long white real
body.
AST- WEEKLY
2+
2+
ry
23
22
n
2l
'll
l 1
lb
1+
t
t+l
ilf
I
t(
<
1?
, g l '32
I
|u
Bullish
Engulfing
Pattern
20
t+*,tlll
I
t8
LL
IITIL]
2D
lq
tt
,il|,ilfr"
|[.
ll
T l
FtB NRRfiPR|1RY JUt.lJUL RU6StP DDI |\]OU
DTD ,93 FtB r]RRAPR
Metastockby EQUISInt'l
l8
t7
15
l+'
\ Morning
i Star
EXHIBIT 3.74. Morning Star and a Spring, AST-Weekly
19
t6
t+
13
T2
1I9
120
Candles
GM- DAILEY
?qn
?qn
38.5
38.0
38.5
38.0
37.5
37.0
36.5
^-+
J(.3
37.0
35.5
36.0
35.5
35.0
34.5
31.0
33.5
Jb. U
35.5
?6n
Tlrr'+'{r;n'oi'*
31.5
31.0
??q
?1 n
JJ. U
32.5
32.0
3 15.
??n
3 15.
'lt n
J"lo,,n",l+1,,,*,qili,nrd
JI.U
?nq
30.5
30,0
29.5
29.0
28.5
28.0
30.0
29.5
29.0
28.5
28.0
0
, fl-Tl
l -r'
{ - 4r
t--l
lr I
07
11
2t 28 ' 93 ll
18
Metastock
lnt'l
byEQUIs
I f-l
t--l 't J
DGIIBIT 3.75. Morning Star and Subjectivity, GM-Daily
The fact that both of these morning star variations appeared near the
same support area meant that while both M1 and M2 were not classic
morning star patterns, they should be viewed nonethelessasbullish clues.
This chart underscores an important point-candles are a form of pattern
analysis, and as such, there is a subjectivity that goes with candlestick
analysis.
In this regard, I once wrote to the Nippon Technical Analysts Association to see how they viewed candle chart patterns that were less than
ideal versions of a pattern. This was their response:"We have found our
discussions very interesting in the sense that you try to be very specific
in determining definitions of japanese exhibit readings while we try to
keep them flexible so as not to exclude all possibilities. This . . . may be
traced to differences in the way of thinking of Westerners who prefer
being precise and definite and Orientals who like to be flexible."
The Patterns
This highlights an important point in that the exhibits I have illustrated are mostly ideal versions of the patterns, but in the real world,
one should not exclude the possibility that a less than ideal version of
that pattern is valid. How do you determine if you should trade from a
less than ideal pattern? Basedon the Japaneseliterature, may conversations with fapanesecandle traders, and my experience,here are a few
suggestions:
1. Wait for more confirmation of that pattern's prediction. For example,
an ideal dark cloud cover should have the secondsession'sclosemore
than halfway into the first candle's white real body. If the closeis less
than halfway into the white real body, then wait until the next session
to see if the market remains weak.
2. If the less than ideal pattern confirms a support or resistancearea, or
if it appears in a very oversold or overbought market, the greater the
odds that the pattern will be a reversal. For example, if there is a
hammer in which the lower shadow is not very long, but if this "hammer-like" line confirmed a 50o/oretracement area, I would view such
action as having all the bullish import as would a more traditional
hammer.
3. A method you may find useful in helping to determine the significance
of a less than ideal pattern is to make a blended candle from that
pattern. Then seeif the blended candleconfirms the pattern's forecast.
For example, look at Exhibit 3.75 (GM) previously discussed.I used
this chart to draw the blended candles from morning star variations
M1 and M2. Notice how each of these blended candleshad long lower
shadows.The long lower shadows of both of the blended candlesand
the fact that both M1 and M2 emerged near the same support with the
long white candle following M2 gave clues that the bears were losing
control of this market.
RECORD SESSIONS
\{ost candle patterns are composed of one, two, or three candles. This
aspectshows one of the major advantages of the candle charts-they can
often send a reversal signal in only a few sessions,whereas bar charts
can take much longer. Although some candle patterns do take longer to
unfold, they are nonetheless extremely valuable. One of these longer
:erm pattern techniques is the eight to ten recordsessions.
When a candle session makes a higher high, the japanese call it a
L21
122
C-andles
record sessionhigh. A lower low is called a record sessionlow. In candle
theory, when there are eight to ten record sessions(that is, eight to ten
almost consecutivehigher highs or lower), it increasesthe possibility that
the preceding trend will change. Exhibit 3.76(A) shows ten record highs
and ten records lows.
Eight to ten record sessionsare so important in ]apan that they have
"the bones of Sakata'sbody." The meaning of
been describedas being
this expressionis that just as the bones, or skeleton, of a person's body
are its foundation, so are record sessionsthe foundation or essenceof
the Sakata charts. (Sakata charts are another name for candle charts.
Sakatawas the port city in which Homma traded. In recognition of this,
there are many references throughout the ]apanese literature to candle
charts being called Sakatacharts.)
I will now discuss how to count record session highs, but the theory
will be the same for record session lows. First, confirm that a low price
for the move has occurred. The top of Exhibit 3.76(A) displays how, after
a new low, the next sessionmade a higher high. This sessionbecame
record session1. Recordsession2 occurswhen another new high is made
(this includes the upper shadow). Note how the session after record
sessionhigh 1 was not a record session.This was becausea new high
RecordSessions
10 recordhighs
I
' ii
10
Startnew
I t ,
|
. l l rI , l
,l
't ,l
' l r1 l r l
Low2
I
Low
t l
I
10 recordlows
High
Low
lr
'
| tltlr'
lr I
7
EXHIBIT 3.76.
Record Sessions
\r
4
?ill
2 l
I
count
\
5
\
'r
9
(A)
(B)
ThePatterns
was not created. Only when a new high was touched was it counted as
record session2.
To count record sessionsin a downturn, first confirm that a new high
has been set. The sessionthat makes a lower low then becomesrecord
session1. The next lower low then becomesrecord session2.
The theory of record high sessions is that during a rally, a trader
should stop buying after eight to ten record sessionhighs (or liquidate
longs, or sell short with the appearance of a bearish candle signal after
theserecord sessionhighs). The samephilosophy, but in reverse,should
be considered after a decline with eight to ten record sessionlows. To
wit, a trader should stop selling after about eight record sessionlows (or
cover shorts, or buy looking for a bounce with a bullish candle signal
after eight or more record sessionlows).
The record sessioncount need not be consecutive.A few sessionsof
consolidation can be ignored when counting the new highs or lows.
Generally, there should not be more than two or three sessionsof sideways action between the record sessions,nor should there be a sharp
move counter to the record sessiontrend.
The reason that record sessionsshould be almost consecutivehas to
do with the underlying concept of record sessions.In the caseof eightten record sessionhighs (lows), the market becomesoverbought (oversold). In an overbought (oversold) situation, the market becomes vulnerable to a price dip (rally) as those who are currently long (short) may
decide to take their profits.
The market can relieve an overbought or oversold situation in one of
two ways-by trading laterally or by experiencing a sharp price correction. If the market corrects the overbought or oversold situation by either
of these methods, the record sessioncount is no longer valid since the
market is no longer overextended, and thus is less vulnerable to a correction. For example, in Exhibit 3.76(8), observe how the market got to
record sessionhigh 5, then quickly sold off for three sessions.Because
of the extent of the selloff during thesethree sessions,the market relieved
its overbought condition. As shown, a new count is then started after
low 2.
Do not be too concernedwith the specificnumber of record sessions.
The eight to ten record sessionrule is a guidepost. Each market has its
own personality. |ust as those who follow cyclesmay find that different
markets have different cycles, so some markets may correct after six or
trvelve record sessioninstead of the more normal eight-ten sessions.
In Exhibit 3.77, ftom the low at X, we start the record sessionhigh
count at the next candle since it made a higher high. After record session
8, the market formed two doji. These doji reflected a market that is tiring.
For those who were looking for a reason to exit longs, these doji and the
123
124
Candles
MEXICOTELEPHONE- WEEKLY
60
59
5B
57
56
55
51
53
60
59
5B
57
56
55
54
53
52
tr
3t
5l
50
19
48
17
16
15
11
13
12
1l
3t
50
49
48
47
16
15
11
43
12
1l
|t+'
T
92
AUG SEP OCT
NOU DtC
'93
FEB I1AR APR
I,IAY JUN
Metastock
by EQUISInt'l
EXHIBIT 3.77. Record Session Highs, Mexico Telephone-Weekly
high number of record sessionswere valid reasons.A final push occurred
in late 1992as the extended upper shadow candle-the shooting star-in
record session11 denoted a last gasp for the bulls.
Exhibit 3.78'illustrateshow a steep price decline that started with a
bearish engulfing pattern dragged the market down over 50o/ofrom its
highs within a few months. After nine record sessionlows, the market
started to stabilize. Exhibit 3.78 is an example of how the candles not
only show the trend of the market, but also can give more insight into
the market's health by the color of the candles. The ]apanese have a
saying, "as different as snow from coal." The short term rally from October (from the bullish engulfing pattern) showed that the bulls were in
chargebased on the seriesof white real bodies (the "snow"). The post
November selloff pictorially displays the market's weaknesswith an almost consecutiveseriesof black real bodies (the "coaI"\.
In Exhibit 3.79, a gravestonedoji appearedin early September.Inter-
The Patterns
125
AMGEN_WEEKLY
80
80
Bearish
z-\
( ,- )Engulfing
7q
70
65
niIli'""'"
''*l*fn
+lIilil
+noht*+
75
'!#nF
55
II
l r
' ll T tlY
OU
fil'
flT
Y
55
hn
'td'"!;,
15
60
15
. ,Il
,Atu'f
]|h
10
It++o!,r0t-.+t
35
, 92
65
50
I
10
70
,93 FEB I1ARAPR I1AYJUN JUL
JUN JUL ..AU6SEP OCT NOUDEC
bYEQUISInt'l
MetaStock
EXHIBIT 3.78. Record Session Lows, Amgen-Weekly
estingly, this gravestone also confirmed that there was a potential top
based on the record sessionconcept. After making a new low at L, the
market on the next day made a higher high. This was record session1.
After record session3, the market took a breather for a few days before
going on to a fresh new high, and then formed record session4. As we
can see,between record sessions3 and 4, the market can trade laterally
for a few sessionswithout intermpting the count for record sessions.
(However, if these sessionsafter record session 5 were sharp selloffs,
then the record sessioncount would have to start again). By the time the
Nikkei gets to record sessions7 and 8 (which are shooting stars), the
market is already in trouble, With the gravestonedoji at record session9
becoming a top.
In Exhibit 3.80, a piercing pattern emerged after a nine-count record
session.As a result, a rebound could be expected. From the 1993high
near $21 to the low of the piercing pattern, we get a 50o/oretracement
35
EXHIBIT 3.79. Record session High and BearishConfirmation, Nikkei-Daily
EXHIBIT 3.80. Record SessionLows and RetracementLevels, Crud.eOil-Weekly
The Patterns
level near $19. This is where the market stalled after the rebound from
the piercing pattern.
CHAPTER4
CANDLES AND THE
OVERALL TECHNICAL
PICTURE
# a + o E x E t mb d
"He Who Sitsin a Well to Lookat the Sky Can SeeBut Little"
"Action that ignores
A ;uputt"se book that I had translated states that,
the condition of the market is only asking for a loss and an ambush
encounter."l This picturesque saying (using the typical military analogy
so common in ]apanese technical analysis) means that you must consider
the overall market condition before trading with the candles. Otherwise,
"loss and ambush encounter."
you may be in for a
A member of the Nippon Technical Analysts Association wrote to me
that he views the overall technical picture as more important than an
individual candle pattern. I certainly agree with that sentiment. Effective
candle charting techniques require not only an understanding of the candle patterns, but a policy of using sound, coherent trading strategiesand
tactics. It is unfortunate that some traders who know about the candle
patterns often ignore such tactics. The candles are a tool that must be
in.otpotuted with other trading guidelines. In this sense, I have always
viewed the candles as being another color, albeit an important one, on
my technical palette.
A disciple of Confucius once asked him who would he take to war
with him. Confucius answered that he would not want someone who
did not care whether he lived or died. He would take someone who
approached difficulties with appropriate caution and who preferred to
129
130
Candles
succeedby strategy.And strategyis the focus of this chapter; here I show
the importance of such strategic principles as using stops, determining
the risk and reward aspectsof a trade, observing where a candle pattern
is in relation to the overall trend, and monitoring the market's action
after a trade is placed. By understanding and using these trading principles, you will be in a position to most fully enhancethe power of the
candles. By the end of this chapter, you should understand that what
emergesbefore and after a candle pattern is a critical element of trading.
STOPS
"Euen Monkeys
FalI from Trees"
There should always be a price at which you say your outlook is wrong.
The protective stop out level is that price. No matter how reliable the
\echnrca\ too\, there wil\be trmes w\ren t\re s\gna\ obta\ned,hom t\rat too\
is wrong. By using stops, you are defining the risk of a trade. ln effect,
the use of stops provides one of the most powerful aspects of technical
analysis;it offers a risk managementapproach to the market.
Many of the candlestickpatterns can become a support or resistance
area. For example, a dark cloud cover often acts as resistance.As such,
for those who are short, a protective buy stop can be placed on a close
above the high of the dark cloud cover. In Exhibit 4.1.,we see that an
uptrend that started in early January stopped via a dark cloud cover as
the market went from an uptrend preceding this pattern into a lateral
band after the dark cloud. The dark cloud cover acted as resistancefor
the next 7 sessions.But the rising window and then the close above the
high of the dark cloud cover were signs that the market was ready to
once again advance.
It is human nature that when price action turns against you, wishful
thinking enters the picture. For instance, after the market pushed above
the stop out level in Exhibit 4.1 (the high of the dark cloud cover), some
traders who were short may have hoped that the market would then turn
around and decline. But in the market, there is no room for hope. Staying
in a market that moves through a stop out level in the hope that prices
"To lean a
will then turn is, as a picturesque Japaneseproverb states:
ladder against the clouds."
In Exhibit 4.2, we see that a rising window emerged in April 1993.
Basedon candle theory, this window should be support, as it was during
the September 1993pullback. Whether a trader bought on a pullback into
the window, or whether he or she was previously long, a protective sell
I
Candlesand the OperallTechnicalPicture
EXHIBIT 4.1. Exceeding a Dark Cloud Cover, Bonds-March 1993
EXHIBIT 4.2. Stops and Risk Tolerance,Gold-Weekly
131
132
Candles
stop should be on a weekly close (i.e., a Friday close)under the bottom
of the rising window. Note how, in this market, the window was pierced
on an intra-weekly basis, but the bears did not have enough itaying
power to maintain prices under the bottom of the window by the close
of the week. In this case,the window held as support, but noi all traders
would have been able to stand the emotional ride in this market as prices
-or
pulled under the window and then sprang back above the bottom
tnu
window before the Friday close. This example illustrates how trading
depends to a large extent on a trader's temperament.
As shown in Exhibit 4.3, Amgen held the rising window as support
when it pulled back to there in November. The iuccessful test oJ the
rising window confirmed the health of the market. The rebound from the
successfultest of the window pushed prices above $75. At that point,
the market gave some clues of trouble based on a harami pattern. over
the next few weeks, the market started to top out via a claisic head and
shoulders pattern denoted by s-H-s (the |apanese call the head and
shoulders a Three-Buddha
Pattenc).\A/henprices penetrated the neckline
AMGEN-
DAILY
'(HaraniS.t0il
H
75
7n
(F
50
75
o,otot?
"l*o'*t*,iil*u,,.,,""n",
70
Window
Holdsas
Support
'1,il1*l'"'"-'s
suPPort65
'
EE
50
55
too'il*l
n
50
50
+5
+5
f+' +0
+0
?6
'92
2 6 N 0 9 1 5 2 3 D D Z l + 2 12 8 ' $ l l
MetaStockby EQUISInt'l
EXHIBIT 4.3. Stops, Amgen-Daily
18 25 F 0 8 t 5 2 2
Candlesand the OaerallTechnicalPicture
of this head and shoulders top, it should have been a sign for longs to
exit. A final warning about the weak state of the market was given when,
in early 1993,the bears finally managed to drag prices under the rising
window, which heretofore had been support. This break of the window
could have been another protective sell stop signal for existing longs.
RISK/REWARD
"The Sidethat Knows When to Fight and When Not to Will Takethe
Victory"
I often find that, after my seminars, people in the audience are so excited
about the new "light" offered by the candles that they cannot wait to
get back to their offices or homes to place a trade based on a candle
pattern. However, as one of the books that I had translated stated (a
trader must) "wait for time to ripen, waiting for just the right moment
is virtuous, a patient mind or spirit is essential."2 ltt other words, just
"time is ripe"
becausethere is a candle pattern, it does not mean that the
for a trade. I try to warn my audiencesthat one of the most important
aspectsin determining the "right moment" for a trade is to inspect the
risk/reward aspectof the market at the time the candle pattern is formed.
In this context, a trader who was in an institutional trading group for
"You were certainly
whom I gave a special seminar wrote to me that,
correct*a little knowledge can be dangerous. We're all running around
the office shouting'Doji, Doji."'
A stop, by defining the risk of a trade, is one of the components of
the risk and reward picture. The other component is the price target of
"reward." There are many ways to determine
the trade, or the potential
price targets, from Elliott Wave to previous support or resistanceareas.
Becausecandle charting techniquesusually do not provide a price target,
I often recommend the joining of Western technicalswith candles. The
candlesare excellentfor sending a reversalor a continuation signal, while
the Western tools, such as retracementsor trend lines, can help provide
a price target. You probably already have your own methodology to
obtain price targets.
A key point to remember is that unless there is an attractive risk/
reward ratio at the time the candle pattern is completed, stay away from
"His potential is that of the fully
the trade. As a ]apaneseproverb says,
drawn bow-his timing the release of the trigger." The timing of the
"release of the trigge{'depends on the risk/reward aspectof the trade.
There will be times when you should not release the trigger. For
example,without an attractiverisk/reward ratio at the time that a bullish
or bearish candle signal emerges,the trade should be ignored (unless a
133
1U
Candles
trader is using the candle signal to offset a position). Another time to
step away from the market is when there is an exchangeof big black
candles and big white candles: "Just like it was an earthquak" of *ug_
nitude 8,"3 as one of the ]apanesetechnicalanalysisbooks states.As this
sameJapanesebook graphically statesabout trying to enter such a market, "Dying in vain is not fun.,,4
As shown in Exhibit 4.4, there was a bearish engulfing pattern in
early september. Based on the concept that the high of the blarish engulfing pattern should be resistance,a trader wanting to sell short could
place a protective_buystop above the high of this beirish engulfing pattern at 465. This defines the risk. To obtain a target, the tradei .o,rld, fo.
instance, look for the mid-August rising window as a support area on
any price retreats. with this window as a target, the appearanceof the
bearish engulfing pattern made for an attractiv'eshort sale becauseof the
relatively low risk stop as compared to the target.
In Exhibit 4.5, we seethat a rally that started with a bullish engulfing
pattern in Januaryformed a rising #ir,do* raterthat month. Two sessions
after this window, the market formed a bearish engulfing pattern. A
question that a trader who is looking to sell short on that signai must ask
EXHIBIT 4.4. Candlesand the Aspects of Risk/Reward,s & p-December \993
Picture
Candlesand the OaerallTechnical
Wal-Mart-
DAILY
/
I
A +|
Bearish
Engulfing
Pattern
",+T
32.0
31.D
I
'ililY
t
fl
t
I
Dark
, \ Cloud
*' ' fl T, *
' H
,"*ii*il
r
-
hl',"**
??6
33.0
135
33.0
l" ll + ,
T
ITrl
Rising +
{t I n
33,5
3t5
2Dn
JI.U
anE
30.0
30.0
)oR
29.5
'92
'93
ll
IB
25
DB
1D
MetaStockby EQUISInt'l
EXHIBIT 4.5. Candlesand the Importance of Risk/Reward,wal-Mart-Daily
is: "Does a short sale based on this bearish engulfing pattern offer an
attractiverisk/reward?." (Selling short is relatively rare in the stock market. Nonetheless,this chart can be used as a guidepost for other markets,
such as futures, where short selling is more common.) Looking at the
overall technical picture and considering the risk/reward aspect, such a
trade would not be warranted. This is becauseof the rising window that
preceded the bearish engulfing pattern. A short sale from this bearish
engulfing pattern should mean a stop above the high of the bearish engulfing pattern. With the support at the rising window, this is not an
attractive risk/reward trade since, in this case, the risk and reward are
about equal. A few weeks later, a dark cloud cover arose.Now, with the
high of the dark cloud cover as a stop and the window as a target, this
becomesa more attractive trading opportunity from the short side.
Exhibit 4.5 underscoresthe difficulty of trying to determine which of
the candlestick patterns is more important. In this chart, there was a
136
Candles
bearish engulfing pattern. Normally, that pattern is considered more
bearish than a dark cloud cover becausethe black candle of the engulfing
pattern envelops the entire prior white candle, rather than just part of
the white candle, as is the case with the dark cloud cover. But in this
example, selling short with the dark cloud cover offered a better trading
opportunity than selling short with the bearish engulfing pattern.
As shown in Exhibit 4.6, the appearanceof a bullish candle signal
does not always warrant a new long position. In this chart, we see that
that a bullish morning star was formed by the price action on fanuary g,
9, and 10. The close on ]anuary 10 (the day the morning star was completed) was at $1205.Let us look at whether a buy at $1205is an appealing
trade based on the risk/reward ratio. First, to determine the reward, we
seethat there was a support area from late November near $1220.Based
on the change of polarity principle (where old support becomes new
resistance), a trader who was looking at the market in early january
(when the bullish morning star was formed) might then expect a bounce
to resistance near $1220. So the target is near fi1220.To determine the
risk in this trade, we would use the candle theory that the low of the
morning star pattern should be support. In this case,the stop would be
on a close under the morning star pattern at $1169.
EXHIBIT 4.5.
Risk/Reward, Cocoa-M
arch 1992
Candlesand the OaerallTechnicalPicture
Consequently, the parameters of this trade are: buying at $L205(at
the completion of the morning star pattern), a stop at$1169,and a target
near $L220.This means a $36 risk and a $15 target. Not an attractiveriski
reward trade by any stretch of the imagination! The morale of the story:
do not place a trade just becausea candle pattern emerges. Note how
the bottom of the morning star became support a week later. The rally
from there stalled at the expected 91220resistance area via a high-wave
candle at L and the long black real body at 2. These two candlesformed
a bearish engulfing pattern. Normally, a bearish engulfing pattern after
such a small preceding uptrend is not too important. But in this specific
case, it took an extra significance since it confirmed the $L220resistance
area.
TREND
"It is Easierto Run Down a Hill Than Up One"
"as clouds to the wind and winds
There is a beautiful japanesephrase,
to the blossom." In the context of trading, I would comParethe trend to
the wind and the price to the clouds or blossoms,whose movements are
controlled by the wind. Thus, determining where the most curtent price
is in relation to the trend is of vital importance. This means that a candle
pattern should be viewed in the context of the prevailing trend before
deciding if a new position should be initiated.
The method I usually recommend for incorporating the candle pattefns into the trend is to place a new trade in the direction of the prevailing trend and to offset a position when there is a reversal signal
against the prevailing trend. For instance, bearish candle signals in bull
trends should be used to offset longs (or to take other protectivemeasures
such as selling calls or moving up sell stop levels). But a bullish candle
signal in a bull trend could be used to place a new long position. The
opposite would be true in markets with major downtrends. To wit, initiating a short sale on a bearish candle signal should be the main goal in
a bear market. A bullish signal in a bear market could be used to cover
shorts.
There are many ways to determine trend. (In Part 2 of this book, I
will reveal some popular methods of trend determination used by Japanese traders and investors.) The goal of this section is not to help you
find the best way to determine trend, but to get you to think about some
ways to incorporate trend into your candle analysis. In this section, I will
discuss some of the more common Western methods of trend determination such as trendlines and moving averages.
137
138
For those who would like to learn more about the practical applications of some of the most popular western technical tools, inciuaing
those techniques to help determine trend, I highly recommend the book,
TechnicalTraders Guide to ComputerAnalysis of the Futures Market, by
CharlesLeBeauand David Lucas (Island view FinancialGroup, Torrance,
cA). Do not let the title of the book dissuade you if you do not use
computers to trade. This book is a must for any trader who useswestern
technical techniques.
One of the most basic methods of determining trend is to use a trendline. In Exhibit 4.7, we see how a resistanceline from late June to early
August kept the trend bearish. The candlesgave some early warnings of
a market that was bottoming. Specifically, the hammer in |uly, the m-orning star in early August, and a small rising window in late August (which
also completed an island bottom). yet, all these bullish signals were in
the context of a bear market (as defined by the downward iloping resistance line). It was not until the break above the trendline that a new
bullish trend was confirmed. Note how the rally from this breakout stalled
at september's dark cloud cover. That dark cloud cover then becamea
resistancelevel.
Exhibit 4.8 shows how in early |uly, there was a bearish engulfing
EXHIBIT 4.7. confirming a Trend Reversal, Coffee-December 1991
Candlesand the OoeraIITechnicalPicture
EXHIBIT 4.8. Candle Signals and Trendlines, Five-Year Note-September L993
pattern (the empty spacewas due to a holiday). But looking at the overall
technical picture, including the trendline, it is obvious that a short sale
based on the bearish engulfing pattern would not offer an attractive trade
based on risk/reward levels. This is becausethe target should be the
support defined by the trendline, and a stop should be above the high
of the bearish engulfing pattern. The uptrend was confirmed as broken
when the market closed under the trendline on |uly 19.
Using Exhibits 4.9(A) and (B), I show an examPle of how a bullish
candle signal could be used as a buying opportunity on a pullback in bull
trend. Exhibit 4.9(A) is a chart that shows a nicely defined uptrend support line (the more often a trendline is tested, the more important it
should be). Candle 1 is shown as it looked on the morning of September
15, 1993.Since the sessionwas not yet over, candle l" is not yet formed
for the day (remember that a completed candle needs a closing price).
As shown in Exhibit 4.9(A), at the time the chart was drawn (the morning
of September15), the market had just tested a long-term uptrend support
line. Shifting over to the intra-day 30-minute candle chart in Exhibit 4.9(B\,
note how a bullish engulfing pattern unfolded during the morning of
September 15. The dashed line in Exhibit 4.9(B) represents the same
trendline on the daily chart. We seehow a bullish candle signal appeared
during a selloff to an uptrend support line. This showed the concept that,
139
EXHIBIT 4.9(A). Candlesand Trendlines, Bonds-December 1993,Daily
EXHIBIT 4.9(B). Candles and Trendlines, Bonds-December 1993,Intra_Dav
Candlesand the OaerallTechnicalPicture
141
in a bull trend, we look for corrections on which to buy with a bullish
candle signal.
For those who use moving averageto help define the trend, I illustrate
in Exhibit 4.10 how to use candle signalsto trade within the trend. Based
on the fact that the market is under the moving average, the trend is
down. In such an environment, bearish candle signalscan be used to sell
short and bullish candle signals should be used to cover shorts. For traders who are more risk oriented and may want to buy in a bear market,
use a short-term resistanceareaas a target. In this example,a rally started
with a harami in June. However, as the market got to the S2-weekmoving
averageresistancearea, the candles reflected increasedselling pressure
as shown by the long upper shadow candle at L and the long black real
body candle at 2. For traders who bought at the harami, the resistance
area defined by the moving average should be an area to liquidate. For
those who were looking to go in the same direction as the overall trend
(in this case, sell on bounces), then the aforementioned bearish candle
PAPER_ DAILY
INTERNATIONAL
72.5
n5
If'utl,
'+l
l l - r - - r -
20.0
67.5
'b*ldt
,d.l+
20.0
52 Week Moving Average
I
&.5
?r
I Fatting
Window
55.D
il
*,0"\,[,,,
T
55.0
|1
l+il
Harami
62,5
62,5
r92 ?6
D8
t5
22
t?
2D ?7
MetaStockby EQUISInt'l
EXHIBIT 4.10. Trading with the Trend, International Paper-Daily
t0
t 7 2+
1.42
signals could be used to sell short. The falling window showed that the
bears gave the market an extra pull lower. The long white candles in
mid-|uly was a hint of strength. The rally from these candlesstopped via
a doji that stalled at the moving average resistancearea. This was an
extremely attractiveshort sale since that doji areawas not only at the 52week moving average,but it was also at the falling window's resistance
area. Note how after this sell-off the market bounced back after 9
record sessionlows.
BECOMING A MARKET CHAMETEON
"An ArmyManages
itsvictoryin Accordance
with thesituation
of the
Enemy"
when first placing a trade, you have expectationsabout how the market
should act. However, the market is fluid, ever flowing, and ever changing. As a result, you must continually monitor the mirket,s path to see
if price action performs according to your expectations.If noi, you will
have to take appropriate action. Adapting to changing market conditions
is what I call being a marketchameleon.
Being a market chameleon, that
is, quickly and effectively adapting to a new market environment, is a
vital element to successfultrading. There is an appropriate quote that I
heard years ago. It compares trading to fencing. Ii said thatln trading,
as in fencing, there are the quick and the dead. Being a market chameleon
means that you are quick enough to adapt to the market so as to',live"
to trade another day.
When a trader has a market opinion, there should be a price that tells
him or her that their market forecastis wrong. I will look at this aspect
in Exhibit 4.11. In that chart, there was a dark cloud cover in the latter
part of october. At that point, I turned bearish on this market becausea
confluenceof technical factors hinted that prices would not close above
$36. There were four reasonsto expect any rallies to stall in the $35.50$36.00area.Thesewere:
1. The high of the dark cloud cover at $35.50should becomea resistance
area.
2. A small falling window provides resistancenear g36.
3. The lows of the three sessionprior to the falling window were near
$36. Based on the concept that old support becomesresistance,this
$36 support should be converted to resiitance.
4. A Fibonacci 620/oretracement of the decline from A to B was near
$35.s0.
Candlesand the OaerallTechnicalPicture
EXHIBIT 4.11. Looking for a Price to Adjust a Market Opinion, Crude OilDecember1990
In this case, if the bulls had enough force to close prices above the
top end of my $35.50-$36.00resistance area,I would then have had to
changemy bearish stance.In other words, I would have had to adapt to
new market conditions. We can see that although the bulls tried for a
few weeks after the dark cloud cover to push the market above the top
end of the $35.50-$36.00resistancearea, they failed.
Exhibit 4.12 displays a resistancearea in late Decembernear $20 that
was verffied by a hanging man and bearish engulfing pattern (the space
between these two candles was due to a holiday). The price slide that
began near this $20 area tried to stabilize in early January near the $\9
support areafrom the month before. The long black real body of january
12broke this $19support. Thus, up until that time, all the signalscoming
from the market were negative. However, candle clues that the market
was changing its complexion came with the high-wave candle after the
long black real body. Another warning about having to adjust from a
bearish view to a more constructive view about the market came the
following week with the morning star pattern. Final proof of a turnaround came with a rising window.
143
144
Candles
EXHIBIT 4.12. Being a Chameleon by Adapting to the Market, Crude oil-March
1993
COMPUTERS AND CANDLES
"Euen Beautiful
Things Haoe Disadoantages
and Must be t-Isedwith
Caution"
Many technicalanalystsbasetheir trading strategieson computer testing.
with the widespread use of computers and the popularity of candles,
there may be traders who may want to use computers to find the most
important or reliable candle patterns. For those who may decide to do
such testing, I think it is important that other aspects,besidesjust having
the computer pick out the candle patterns, must be taken into account
with such testing. That is the focus of this section.
The Importance of Where a Candle Pattern Appears
As discussedpreviously, one should never view a candle signal without
seeing the pattern in the context of what happened before the pattern
appeared. This aspect is related to a question frequently asked of mewhich are the most important candle patterns?In answering this, I first
Candlesand the OaeraIITechnicalPicture
suggestthinking about what the pattern is relaying about the market's
action. For example, in comparing a dark cloud cover with a bearish
engulfing pattern, I would normally consider the bearish engulfing pattern as more important. This is based on the fact that the secondsession
of the bearish engulfing pattern has a close under the prior white real
body. The dark cloud cover's secondsession,however, has a closewithin
the prior white real body. As such, the bearish engulfing pattern shows
that the bears had more control of the market as compared to the dark
cloud cover (seeExhibit 4.13).
But candle patterns can never be viewed in isolation. A trader always
has to consider the surrounding technical picture. For example, a dark
cloud cover that arisesat a major resistancearea should be construed as
being more likely a reversal than would a bearish engulfing pattern that
is not at resistance.An instance of the danger of looking at a pattern in
isolation is shown in Exhibit 4.5 on page 135 where, becauseof risk/
reward considerations, a dark cloud cover offered a more attractive trade
than did a bearish engulfing pattern. Thus, looking at a candle pattern
in isolation can be a dangerous procedure. As was nicely expressedto
me by a Japanesetrader, "where you stand is more important than an
individual pattern." As a result, if you decide to test out the reliability
of the candle patterns, remember not to just use a buy or sell signal based
solely on the candle pattern. You must first factor into your analysisjust
where the pattern emerged.
The Question of Determining Specific Criteria for the Pattern
The candle patterns are based on sound psychologicalreasoning. (Think
about what happens with a dark cloud cover. After a strong white session, the market opens higher and then closes well under the white
session'sclose. Doesn't that clearly illustrate how the bears have managed to wrest control from the bulls?) But candles, unlike mathematically
I
Glosefor dark
cloudcover
Closefor Bearlsh
EngutfingPattern
EXHIBIT 4.13. Comparing a
Dark Cloud Cover With a Bearish
Engulfing Pattern
L45
146
Candles
concrete numbers, such as moving averages or oscillators, may not be
easily adaptable to computer testing. A moving averageeither is, or isn,t,
above yesterday's close. This is a yes-no choice for the computer. But
candle signals are not this clear-cut, and subiectivity is required in determining what is or is not a candle pattern.
A classic dark cloud cover should have the close of the black candle
sessionmore than halfway into the prior white's real body. That is a rule
that can be quantified. But what if there were a less than ideal dark cloud
cover in which the close of the black candlestick sessiondid not get more
than halfway into the prior white session's real body? That, based on the
standard definition of a dark cloud cover, would not be a dark cloud
cover pattern and the computer might not pick up such a pattern. The
question then becomes: What happens when a less than ideal dark cloud
cover shows up near a resistance area? Does a computer read that as a
dark cloud cover or does it ignore the pattern? In such a scenario, I would
say that the less than ideal dark cloud cover should be viewed as being
iust as bearish as a more traditional dark cloud cover. This is the scenario
that unfolded in Exhibit 4.14. Note the annotation that has a question
BANKAMERICA- DAILY
55
55
54
54
53
,,,n
,1il1$'+*t*rtt
JI
5I
53
57
t\
5[
50
49
{[oIl'f
19
18
48
47
15
15
17
,g
15
T
45
11
'93 rB 25 t
44
0B l5?7
11 08 15 72 29R
MetaStockby EQUISInt'l
EXHIBIT 4.14. Candles and Subjectivity, Bank America-Daily
1? l9 ?5 fl
&ndles and the OaerallTechnicalPicture
mark after the term "dark cloud cover." This was not an ideal dark cloud
cover becausethe close did not move under the center of the prior white
candle. However, although this was not an ideal dark cloud cover, I still
viewed it as a dark cloud cover for a few reasons.First was the extremely
long upper shadow of the black candle of the pattern. This showed how
quickly prices retreated from the new highs. In addition, by the close of
this black candle, the market was technically damagedbecausethe bears
were able to drag prices back under a prior high (marked H on the chart).
This formed a bearish upthrust. Finally, the lower close after the dark
cloud cover helped confirm the market's inherent weakness.
Thus, even the most basicstep of having the computer find the candle
pattern may causeproblems. So, for those using a computer to pick out
the candle patterns, remember that the candle patterns should be used
as guideposts.While the ideal patterns may be relatively easyto quantify,
the less than ideal patterns are often useful trading signals that should
also be accountedfor. In this context, there is a large degree of subjectivity required. This is no different from standard bar chart pattern recognition.
Placing the Trade
If a candle pattern emerges, does that mean that a buy or sell signal is
automatically given? of course not. As I previously discussed,you should
not basea trade on a candle pattern in isolation. You must firsi determine
the overall technical picture at the time the pattern forms.
As an example of this aspect,let us consider a shooting star. A computer Program that basesa sell signal on the shooting star alone would
have given an improper sell signal if that shooting star also formed a
rising window (this scenariounfolded in Exhibit 3.49 on page 9g). Thus,
having a computer signal a trade just becausea candlu putt".r, emerges,
and ignoring the overall technicalpicture (i.e., the malor trend, the p-rice
action preceding the candle pattern, etc.), courd be a mistake.
Another aspect is the concept of risk/reward discussedearly in this
chapter. |ust becausea pattern appears does not mean that one should
placea trade on the candle signal. For example,what if there is a morning
star in gold, but the risk for the trade is $15 and your objective is also
515?would a long position on that pattern be warranted? In this case,
*re answer is no. \zvhethera trade is warranted or not is dependent on
the risk/reward parametersof the market at the time the pattern is formed.
As an exampleof this, in Exhibit .l.s,lshow two hammers. Hammers
arepotentially bullish signals,but the risk/reward aspectof each of these
L47
148
C-andles
EXHIBIT 4.15. RiskiReward Aspects of a Trade, S & P-Weekly
hammers would not justify a long trade. In both cases,there would have
been a 15-20 point risk (basedon a stop under the hammer's lows) for
a possible 20-25point target (basedon the resistancearea near 425).Thus,
an automatic buy based on a computer trading program would have
worked in this example because the market rallied from both hammers.
Nonetheless, these buy signals would not have been a trade based on
sound money management principles since the risk would have been too
large for the potential reward.
When to Offset a Trade
Placing a stop may be relatively easy with a computer (some testing is
even done without stops-a very dangerous procedure and one that defeats the concept of a risk management approach to trading), but how is
an objective picked? One time, a trader's objective may be last week's
lows, but maybe on the next trade, the objective will be a support line,
or maybe a 50o/oretracement. Every trader has his or her own style, so
be sure to take this into account when merging candles and computers.
Exhibit 4.L6 shows an evening star pattern and a bqllish engulfing
Candlesand the OaeraIITechniul Picture
EXHIBIT 4.16. Candles and Price Targets, British pound-December 1992
pattern. After the bullish engulfing pattern, an up leg could be expected.
However, the price target of such a rally would be based on other technical tools besidescandles since candles do not usually give targets.
Based on the concept that old support becomesresistance,a trader
might have been looking for a move to the ]uly-August support area near
$1.85.For that trader, this trade would not have been successful.However, another trader who uses Fibonacci retracements may have been
more successful since the market made a Fibonacci 38olobounce of the
entire move from the September highs to the September lows. Since the
first trader's $1.85 target was not met, he would say that the bullish
candle signal was not reliable. Yet, for the second trader, whose target
(the 38o/obounce) was reached, the bullish candle signal was successful.
Thus, each trader's style must be taken into account when looking at
testing the candles' reliability.
How you trade with candlesticks will depend on your trading philosophy, your risk adversity, and temperament. These are very individual
aspects.If you decide to test the candle patterns or use computers to
help you trade with candles, it should be based on trading criteria and
rules chosenby you. only by applying the candlesto your markets, with
vour own trading style, can you discover whether the candles will give
vou that extra edge.
149
Candles
Notes
lsakata, Goho, p. 46.
2sakata,Goho, p. 45.
3sakata,Goho, p. 70.
asakata,Goho, p. 70.
a o a o a a o a a a a o a a o
a a a a a a a a o a a o a a
o a a a a a a a a a a a a
PART2
THE DISPARITY INDEX
AND NEW PRICE
CHARTS
a a a a o a a a a a a a a a o a a a a a a a a a a a a a a a o a a a a a a a o a o a
&EtEn(ffiuadn6
"Consider
the Pastand You WiU Know the Future"
a a
a a
a a
a
a
a
a a
a
a
a
a o
a
a
a
a a
a
a
a o
a
a a
a
a a
a
a a
a
a a
a a
a
a
a
INTRODUCTION
a
a
a
.
.
A ;up"t ese book on technical analysis insightfully stated that, "The
market is a fug of war where the strategy is to overrun the enemy territory. In a tug of war, once the balance of power is lost, one side is
pulled and the result is decided. The market often acts this way, and one
should pay attention to the balance of powers."r The new (at ieast in the
West) techniques addressed in Part 2 of this book will help you determine
whether it is the bulls or bears who have the "balance of power.,,
A widely used Japanesetool is the disparity index. It is similar to
Western dual moving averages,but this technique allows for better market timing than do the traditional Western moving average techniques.
The disparity index is addressed in Chapter 5.
The charts detailed in Chapters 6,7, and 8 are called three-line break
charts, renko charts, and kagi charts. of the three, the kagi is probably
the most popular, followed by the three-line break and then the renko
chart. These charts are most closely comparable to the Western point and
figure charts. However, it is not necessaryto understand point and figure
charts to understand any of these Japanesecharts.
fust as candle charts predate bar charts, the threeline break, renko,
and kagi charts predate point and figure charts. These charts are based
on generations of use in the Far East. A member of the Nippon Technical
Analysts Association told me that he had seen a kagi chart of the rice
market dated 1876.However, my research shows that unlike candlestick
153
154
The Dispaity Index and New Pice Charts
charting, which has a rich history, there is very little historical reference
material for the three-line, renko, and kagi charting techniques. This is
probably becausecandles are more colorful, offer more flexibility and are
more widely used. In contrast, the three-line, renko, and kagi charts are
more rigid, offering less room for subjective interpretation, and their use
has mostly been limited to the management level of ]apanesefinancial
firms.
As bar charts differ from point and figure charts, the three-line break,
renko, and kagi charts differ from candle charts. With candle charts, a
new candle line is added to the chart at every session,whether the price
of that sessionmakes a new high, a new low, or is unchanged. With the
charting techniquesto be addressedin the rest of this book, prices must
go to a new high or low before a line on the chart can be added. Since
"The
the market has to go to a new high or low, I have entitled Paft 2
Disparity Index and New Price Charts."
Another difference between candle charts and the three-line break,
renko, and kagi charts is that these new techniques ignore time and are
dependent only on price changes. Since the market is not controlled by
time, but by price movement in these charts, the traditional ]apanese
methodology of drawing them does not include time on the horizontal
axis. However, in the charts in this second half of the book, I have included a rough measure of time on the horizontal axis to help provide
referencepoints for my discussions.
The three-line break, renko, and kagi charts share similarities with
one another, but there are discrete and interesting differences between
each of these charting methods. Each chart and its related techniques
will be described in detail later, in their respective chapters. For some of
these new techniques, a trader will need to choosea pre-specified reversal
amount in order to draw a reversal line. In others, it is the market action
that will provide the signal to draw a new line. While the three-line break,
renko, and kagi charts may be different from one another, they are all
powerful weapons that should be part of a trader's technical arsenal.
Some of the advantagesof these new charts include:
L. Making support, resistance,and congestionareasmore evident
2. Capturing the significant moves by filtering out irregular price fluctuations
3. Making the market's overall trend more apparent
4. Providing a broader view of the market by compressing the price action and offering a longer term perspective
5. Helping to determine the time to offset positions: Becausethe candles
do not, as a general rule, provide a price target, the reversal signals
sent out by these new techniques can be used to exit a market position
lntroduction
6. Providing a means of technical analysis for markets that supply only
closes.This is becausethesetechniquesrequire only the closingprices.
Thus, mutual funds and yields on financial instruments such as Tbonds can be analyzed using a three-line break, renko, or kagi chart.
Becausethree-line break, renko and kagi charts are slower to react
than candle charts, they are frequently used by longer term investors.
However, traders with shorter time frame orientations will find that these
charting tools provide a practical and powerful method to determine
trend direction. Once the trend is determined, candle signalscan be used
to trade in the direction of the prevailing trend.
As will be explained in the upcoming chapters, the sensitivity to the
three-line break, renko, or kagi charts can be adjusted by changing reversal criteria. With each of these charts, I will show you how to adjust
the chart's sensitivity. Short-term traders may want to make the charts
more sensitive to the underlying price action. Those who are more concerned about a broader market perspective may want to use a chart with
larger reversal amounts so as to get more information on a chart. This
should help to obtain a historical perspective. This brings out another
important advantage of these new charts; by changing the reversal criteria for these charts, a trader can adjust the sensitivity of the charts to
his or her trading needs.
Generally, the more sensitive the chart, the greater the number of
trading signals and the greater is the possibility of whipsaws, but the
soonerit may get you into a new trend. A disadvantageof large reversal
amounts is that by the time the trend reversal is made the market will
be more distant from the top or bottom.
Choosing a reversal is subjectiveand dependent upon many aspects,
including the market's volatility, the price of the underlying commodity
or stock, a trader's trading style, and his or her time frame orientation
and risk tolerance. Consequently, I will not attempt to find the optimum
reversal amount, but I will let you know some of the more popular reversal criteria used by fapanesetraders.
These new price charts are usually less flexible than are candle charts.
This is because, with candle charts, there are more graduations of a reversal signal. For example, a small real body after an uptrend could be
viewed as a slowing of upside momentum, but not necessarilyas a price
reversal. For the new techniques in Part 2, prices either do or do not
provide reversal signals.
An important principle about trading with these new charts is that
they are usually based on closing prices, so a reversal signal is not confirmed until the close. By that time, the reversal amount may well be
exceeded.For example, if the reversal amount is $2, the market would
L55
155
The Dispaity lndex and New Pice Charts
have to close either higher or lower by $2, but by the time the market
closes,it could be $4 higher or lower. As a result, a trader could lose $2
of a potential move. Some Japanesetraders circumvent this problem by
initiating a light position if the reversal amount is met or exceededon an
intra-sessionbasis. If the market then closesby the reversal amount, they
can either add more at the close or wait for a correction to add more. If
the market fails to confirm the reversal by the close, the traders would
offset the light position they had earlier added.
Most commonly the closing price of the day or week is used to construct the three-line break, renko, or kagi charts. Because of this, the
focus of Chapters 6 through 8 will be on daily and weekly charts. However, some traders in japan use intra-day kagi charts (three-line break or
renko charts are not normally used on an intra-day basis-perhaps these
charts have been less successfulthan intra-day kagi charts). Thus, for
traders who have the time and the data, kagi charts can be constructed
on an intra-day basis using tick-by-tick data.
Chapter 6 will discuss the three-line break chart, Chapter 7 the renko
chart, and Chapter 8 the kagi chart. Each chapter witl be segmented the
same way. Each of these three chapters will begin with an Oaensiewto
give a flavor of the technique. Do not worry that if, after the overview,
you do not have a grasp of the technique. That will come with each
chapter's next section-Construction. This is where I provide a step-bystep written and visual guide to building the chart.
After completing the section on constructing the chart, you should
have a full understanding of the underlying technique. The TradingTechniquessection, at the conclusion of each chapter, will then show you the
more popular trading techniques for that charting method. At the ends
of Chapters 6, 7, and 8, I have supplied the data necessaryfor you to
draw practice threeJine break, renko, and kagi charts. The answer charts
are provided on the pages following each of these sessions.
There are many ways to trade with these new charts. IA/hile I will
focus on some of the more popular trading techniques used in fapan,
these are by no means all of them. With almost every |apanese trader to
whom I spoke, or every article or book that I had translated,I cameaway
with a new trading technique. This tells me that the three-line break,
renko, and kagi charts are limited only by your trading imagination.
Consequently,my goal in Part 2 is to help you build a solid foundation
upon which the scaffolding of your own ideas can be built.
Note
lOyama, Kenji, p.
52.
CHAPTER5
HOW THE IAPANESE USE
MOVING AVERAGES
E,AtE€=+
"MoneyGrowson the Treeof Patience"
r
ln ]apan, as in the West, moving averagesare used as a valuable trading
tool. Some of ]apan's moving averages techniques include golden and
dead crosses, the disparity index, and the moving average divergence.
Basedon my work and discussions with Japanesetraders, it appears that
the most popular moving averagesare the 5-, 9-, or 25-day averagesfor
shorter term traders, and for longer term traders, the 73-,26-week or the
75- and 2@-day moving averages. However, just as in the West, many
japanese traders have their favorite moving averages.
THE GOLDEN AND DEAD CROSS
The ]apanese use dual moving averages in which they compare shortand long-term averages. For example, they will compare the 13- week
and 26-weekmoving averages.As shown in Exhibit 5.L, rt a shorter term
moving averagecrossesover the longer term moving average,it is viewed
as a bullish sign. The ]apanese call such a crossover a goldencross.A dead
crossis a bearish indication that occurs when a short-term moving average
crossesunder the longer term moving average.
In Exhibit 5.2, the 26-week moving average is shown as a solid line,
and the 13-weekmoving averageas a dashed line. When the shorter term
moving average moved under the longer term average in |uly 1992 it
157
158
The Dispnity lndex and Neu)Pice Charts
Dead
Cross
Short-termMovingAverage
EXHIBIT 5.1.. Golden and Dead Cross
Long-term
MovingAverage
created a bearish dead cross. In November 1992, the l,3-week moving
averagewent above the 26-week moving average, thus completing a bullish golden cross. observe how the hanging man session in May 1993
(which, during the next session, became part of a bearish engulfing pattern) hinted at a correction, as did the dead cross a few sessionearlier.
DISNEY_WEEKLY
+7
+5
+7
+5
+5
{5
++
+3
+2
+l
+0
<H
38
37
35
++
+3
+2
+l
+0
t+;+,il|il
39
38
v
36
35
?6
3+
3+
33
32
31
3D
29
28
27
26
'13Week
MA
JJ
5t
26 WeekMA
<l
?n
IJ
28
27
26
,91 ,92 F 11 A II
J J
R S D l-| D ,$ F r
MetaStockby EQUIS Int'l
EXHIBIT 5.2. Golden and Dead Crosses,Disney-Weekly
A |1 J J
R
How the lapaneseUseMooing Aoerages
THE DISPARITY INDEX
The disparity index (or disparity ratio), compares, as a percentage,the
latest closeto a chosen moving average.For example, when the L3-week
disparity index is -25o/o,it means that the market, based on the close,is
25olounder the 13-week moving average. A 200-day disparity index of
*I2o/o means that the current close is 12o/oabove the 200-day moving
average.
The ]apanesewill say, for example,that, "the separationbetween the
price and the L3-week moving average expanded to 50o/o"or "that the
market was an unusual 3Lolobelow its L3-weekmoving average." These
are references to the disparity index in which the current price is compared to, in both of these cases,the L3-weekmoving average.
Exhibit 5.3 shows an example using a 9-day disparity index. Looking
at that exhibit:
Area 1. When the disparity index is at 0 (shown at L), it means that
today's price is the same as the chosen moving average(in this
case,the 9-day moving average).
Area 2. When the disparity line is under 0, it means that today's price
is a percentageunder the chosen moving average.At period 2,
for instance, the current close is t2o/obelow the 9-day moving
average.
Area 3. When the disparity line is above 0, it means that today's price
is a certain percentageabove the chosen moving average. For
instance,at point 3 in Exhibit 5.3, today's price is 15oloabove the
9-day moving average.
Trading with the Disparity Index
In much of the material I had translated there were often referencesthat
the market should be at a high- or low-price level before acting on a
+15
+10
+5
0
-5
-10
-15
EXHIBIT 5.3. The Disparity Index
L59
160
The Disparity lndex and New Pice Charts
candlestick reversal pattern. An example: "The probability is high that
at a low-price level, a harami cross is a signal that the bottom is near and
a harami cross at a high-price level is a signal that the market is close to
a top."r Another example: "If the koma (this is the Japaneseterm for a
spinning top or a small real body candle) appears after some indication
that the market is^at a low price, then to an extent, one can buy some
and feel at ease."2
Of course, the question arises as to what constitutes a high- or lowprice area. Some traders have their own methodology to determine
whether the market is at a high or low price. They may, for example,
consider it at a low area if the market is near a major support area, or if
it is at a 50o/oretracement area. other traders may gauge high or low
levels on the relative strength index or stochastics,or on an Etliott wave
count.
A method used by some Japaneseto determine whether the market
is at a high- or low-price is by using the disparity index. This is because
the disparity index is an effective mechanism to show if the market is
oversold or overbought. Remember that an oversold environment unfolds when prices descendtoo quickly. In theory, the more oversold the
market, the more vulnerable it becomes to a bounce. An overbought
market is when prices ascend too far too fast, thus making the market
susceptible to a correction. In this regard, a high disparity index reading
can show that the market is overbought and a low disparity index could
reflect an oversold market.
Exhibit 5.4 typifies how the disparity index can offer value-added
analysisto a candle chart. Note than an oversold or overbought indication
based on the disparity index will depend on the individual market and
the chosen disparity index. For this stock, when the 13-week disparity
index reached the * 10o/oarea, the market became overbought. At a disparity index near -LOo/o,the market becomes oversold. By using this
extra information imparted by the disparity ratio in Exhibit 5.4, we can
get more confirmation of candle signals. Specifically:
L. As touched uPon in Chapter 2, a doji becomesa more viable signal
if it appears in an dversold or overbought market environment. In
this case, the doji at 1 emerged at a time when the market was
oversold (as gauged by the disparity index). This hinted that Delta
was ripe for a bounce or sideways action to easethe market's oversold condition. The long white candle after the doji helped confirm
the bullish implications.
2. At time period 2, the market showed signs of overheating, as reflected by the high disparity index. During the same period, a series
How the lapaneseUseMoaing Aoerages
161
DELTA_WEEKLY
ID
l0
D
-10
0
-10
7
B
75
75
7D
70
65
65
50
50
55
55
EN
50
D J92 F N H N
J J
A S D N D , $ F N A
1 1J J
Metastock
bYEQUISInt'l
EXHIBIT 5.4. The Disparity Index as Overbought/Oversold Indicator, Delta-Weekly
and 13-WeekDisparity Index
of long upper shadow candles demonstrated that the bears were
aggressively dragging down prices from the $75 area.
3. The candle at session3, with its long uPPer and lower shadow, was
a high-wave candle. This candle was also the second session of a
harami pattern. Both of these were signs that the market was losing
its prior downward and directional bias. These candle patterns coincided with a low disparity index. This combination of candle signals
and the oversold disparity index reading implied that either a bounce
or sideways activity could be expected. An oversold condition can be
relieved in one of two ways: either by a sharp bounce or by sideways
action (the ]apanese call sideways price activity boxactionsince prices
look like they are locked in a box). After this harami, the market
"box action," the disparity
traded laterally for two months. By this
index moved off its low reading. This showed that the market was
no longer oversold. As a result of not being oversold, the market
162
The Dispaity lndex and New PrtceCharts
once again became vulnerable to another move lower. (Note the
hanging man before the renewed price decline.)
4. Another doji appeared at the same time as the 13-week disparity
index was near -10o/o.This should tell a trader that the market was
in an oversold environment that should be closely monitored-especially becauseof the doji. The tall white candle on the sessionafter
the doji completed a morning doji star pattern.
5. The disparity index moving towards an overbought condition and a
dark cloud cover warned that the upside drive was losing force.
6. This is a good example of how the disparity index can help avoid
buying in a market that is vulnerable to a correction. A tall white
candle at 6 implied a stronger market lay ahead. However, a *!0o/o
disparity index reading at that time showed that prices had ascended
too far too fast (i.e., became overbought). The disparity index thus
provided a warning sign not to buy the market. It turns out that
candle 6 completed a last engulfing top pattern (in which a white
candle envelops a black candle in an uptrend) that was confirmed by
the next session'sweaker close.
7.,8. These black real bodies, especiallythe long black body at 8, normally imply continued weakness.But the oversold nature of the market, as measured by the disparity index, hinted that further down
moves were unlikely. Also, the white candle after the black candle
at 7 had a long lower shadow. This also offset someof the bearishness
of the black candle.
9. A classiccombination of an overheatedmarket (basedon the elevated
disparity index) and a bearish candle pattern (the bearish engulfing
pattern). The fact that this bearish engulfing pattern appearedat the
resistanceareafrom October 1992(at 6) further reinforcedthe outlook
that Delta was at an important technical juncture.
10. Here we see how an oversold market joined with a bullish candle
signal (the hammer at 10) strongly hinted of higher prices to come.
In this chart, the L3-week disparity index gave extreme readings in
the *10o/oarea. However, the markets you follow will probably have
different disparity zones that act as an overbought or oversold reading,
so it pays to experiment.
As discussed above, the disparity index is a useful tool to weigh
whether the market is overbought or oversold. As shown in Exhibit 5.5,
the *15oloand -15olo readings on the 13-period disparity index reflect
times when this market becomesoverbought and oversold. overbought
How the lapaneseUx Moaing Averages
163
S & P DEC1993AND13 PERIODDISPARWINDEX
1
?
1
0
-t
T
I
0
-l
-2
- L1
470
455
160
ill+.
155
450
115
440 .illf
435
'33
JUN
,,*ilht''*{r*nutrh1flr*o*fimfl'il
B
JUL
RU6
stp
OCT
|'lOU
bYEQUISlntl
Metastock
EXHIBIT 5.5. The Disparity Index as a Trend Indicator, S & P December 1993,and
13-Day Disparity Index
readings occurred at time frames A, C, and E, while oversold indications
arrived at time frames B, D, and F. However, in between these overbought and oversold levels, the disparity index could be used as a tool
of trend determination. In this context, while the disparity index is expanding, it conveys a bull trend. If the disparity index declines, it echoes
a bear trend. In Exhibit.5.5, note that between the overbought reading
at A and the oversold reading at B, the index was in a downtrend. This
confirmed that the price trend was also down. This bearish confirmation
with a falling disparity index came from C to D and from E to F. Bull
trends were corroborated via an ascending disparity index from B to C
and from D to E.
Exhibit 5.6 shows another use for the disparity index, that of a tool
to monitor divergence. Note the downward sloping dashed line on the
disparity index connecting the peaks at A and B. At the same time the
disparity index was at B, prices had made a new high for the move-yet
170
165
150
155
150
{15
410
135
164
The Disparity lndex and New PriceCharts
.66
.6.1
.62
.6
.54
.56
.54
.52
.5
ReutersGraphics
EXHIBIT 5.5. The Disparity Index and Divergence,DeutscheMark-13-Day
Disparity Index, Daily Spot
the disparity index at B was lower than it was at A. This createda bearish
negative divergence in which prices reached a new high and the disparity
index did not.
THE DIVERGENCE INDEX
The Japanesealso have a moving average oscillator called the diaergence
index. The name is derived from the fact that this technique measures
how far the price diverges from the chosen moving average.The divergence is calculated by taking the current price and dividing it by the
chosenmoving average.Thus, a 13-daydivergence of.102o/o
would mean
that the close today is 102o/oof the 13-day moving average.A 200-day
divergenceof 97o/owould mean that today's price is 97o/oof the 200-day
moving average.
The divergence is the same as the disparity index; it is just scaled
165
How the lapaneseUseMoaing Aaerages
UNIONPACIFIC
200 DayDivergence
l l 3
ll5
110
il0
105
105
100
100
95
95
,92 JUL AU6
SiP OCI NOUDTC '93 FIB ilAR NpR ilAY JUN JUL RUO SIP OtT
UNIONPACIFIC
l5
200 DayDisparityIndex
15
l0
t0
5
5
0
0
-5
-5
,S2 JUL RU6
SEP OCI NOUOIC '93 TIB ilRA RPRI]AYJUN JUL RUGStP OCI
Metastock
by EQUISInt'l
EXHIBIT 5.7.
200-Day Divergence and Disparity Index
differently. For example, a 13-day divergence of. t02o/omeans that the
market is 2o/oabove the 1,3-daymoving average. A 13-day disparity reading of *2olo also means that the market is 2o/oabove the 13-day moving
is the same as the disparity
average.In other words, a divergence of 102olo
index being *2o/o.A divergence of 93olohas the same implications as a
-7o/o disparity index.
Exhibit 5.7 shows the disparity index and the divergence indicator on
the samestockfor the sametime period. Note that the lines are the same;
it is just the way the vertical scale reads that is different. Thus, all the
techniquesused for the disparity index would be the same as those used
for the divergenceindex.
Just as many computer system traders experiment with moving averages,so you may want to consider experimenting with divergence.As
an example of this, I have the following study done in the 1980sby the
Japaneseto statisticallytest the Nikkei with its divergence.3
166
The Dispaity lndex and New Price Charts
All the values below are within 2 standard deviations (95Yoprobabil-
itv):
Divergence in a rising market:
Divergence in a falling
market:
25- day divergence 99-104o/o
75- day divergence 100-107o/o
200-day divergence 102-1100/o
25-day divergence 96-1010/o
75-day divergence 93-100o/o
200-day divergence 90-99o/o
This study shows that, for example, using the 200-day divergence,
when the Nikkei is rising, there is a 95olochance that the divergence will
be between 102o/o
and 110olo.
This would mean that if the 200-davdivermoves
above
1I0o/o,it is considered excessiveand there is increased
Sence
likelihood that the market is vulnerable to a correction. This concept could
be used as a time to move out of long positions in the belief that the
market is reaching the high end of its current bull leg.
In this discussion,remember that high divergencedoes not necessarily mean that prices will reverse. It is just that the market may be in the
throes of speculativefever or panic selling (in the caseof low value di
vergences), and the likelihood of the move continuing in the same direction decreasesas divergencebecomesmore extreme.
Notes
lHoshi, Kazutaka,p.
107.
2lshii, Katsutoshi, p.
52.
3Analysisof StockPice
in lapan. Tokyo, |apan: Nippon Technical Analysts Association 1986, pg.
104.
CHAPTER6
THREE-LINE BREAK CHARTS
b6ffiA/ztrUr(86
"Weigh the Situation,ThenMoue"
A;upun"se trader describedthe three-line break chart as a "more subtle
form of point and figure charts where reversalsare decidedby the market
and not by arbitrary rules. That means we can gear it to the strength and
dynamism of the market."1
As shown in Exhibit 6.1,,the three-line break chart looks like a series
of white and black blocks of varying heights. A new block is in a separate
column. Each of these blocks is called a line. Using the closing price, a
new white line is added if the previous high is exceededand a new black
line is drawn if the market reachesa new low for the move. If there is
neither a new high nor a low, nothing is drawn.
If a rally (sell-off) is powerful enough to form three consecutivewhite
lines (three black lines), then the low of the last three white lines (the
high of the last three black lines) has to be exceededbefore the opposite
color line is drawn (this procedure is explained in detail later in this
section).The term "three-line break" comesfrom the fact that the market
has to "break" above (or below) the prior three lines before a new opposite color line is drawn. Here again, as discussedin my first book, we
seethe importance of the number "three" in Japanesetechnicals.
A major advantage of the three-line break chart is that there is no
arbitrary fixed reversalamount. It is the market's action that will give the
indication of a reversal.
Other names for the threeline break chart include:
1.. three-stepnew price;
2. new price three-line break;
167
168
The Dispaity Index and New Piu Charts
3. surpassingthree lines;
4. the threeJine turnaround method; and
5. new price three-stepbars.
CONSTRUCTION OF THE THREE-LINE BREAK CHART
For the following explanation detailing construction of the three-line break
chart, I use the data,in Table 6.1. This data is used to construct the threeline break chart shown in Exhibit 6.1.
The three-line break chart is based on closing prices. The price at
which the chart is started is called the base price.
OUREXAMPLE;The baseprice is
135.
TABLE 6.1 Prices for the Three-Line Break Chart
Displayed in Exhibit 6.1
Session
't
2
3
4
5
6
7
8
9
10
11
12
13
't4
15
16
17
18
19
20
C\osingPdce
Session
C\osingPrice
135
132tr
1281
133130130132lU1391
1371451
1581
1471431501491601
1641
1671
156lJ.
21
22
23
24
25
26
27
28
29
30
31
32
33
1651581
7711
173t
169ln1
1801
1761701tr
775179773170170168J
165J
17117517911
175-
u
35
36
37
38
39
40
Legend
l-New high: white line drawn.
J-New low: black line drawn.
(-)-Price within prior range: no line drawn.
tl-White: turnaround line.
lj-Black: turnaround line.
Three-LineBreakCharts
e7l
' 180
h (3e)17e
180
(24) 173
170
(2e)
170
(3s)
( 1 8 )1 6 4
168
(36) 165
160
150
140
(e)13e
( 1 )1 3 5
130
132
e1l
'
(3) 128
EXHIBIT 6.1. Example of a Three-line Break Chart Based on Prices from Table 6.1.
(Figures in ParenthesesRefer to Session Number.)
169
170
The Dispaity lndex and New Price Charts
Drawing the first line: Comparetoday's price to the baseprice.
Rule 1. If today's price is higher
than the base price, draw a white
line from the base price to the new
high price.
price
Today's
1-
lJ+
Baseprice
or
Rule 2. If today's price is lower
than the base price, draw a black
line from the base price to the new
low price.
l:H;"',,""
or
Rule 3. If today's price is unchanged from the base, do not
draw a line.
OUR EXAMPLE: From Table 6.L,
during session2, the market closed
at 132. This was lower than the
baseprice of 135.Thus, a black line
is drawn from 135 to 132.
135(BasePric4
l:
Drawing the second line: Compare today's price to the high and low of
the first line. A second line is drawn only when today's price exceeds
the range of the first line.
Rule 4. If today's price moves
above the top of the first line, shift
over a column to the right and
draw a new white line from the
prior high (in this case 135) up to
the new high price.
New high
Priorhigh
Blackor while
or
Rule 5. If the price is lower than
the low of the first line, move a column to the right and draw a new
black line down from the prior iow
(in this case 132) to the new low
price.
or
Rule 5. If the price holds within
the range of the first line, nothing
is drawn. Thus, in our example, if
the price is between 135 and 132,
no new line is drawn.
h:::::.'-
Prior low ---------->
Three-LineBreakCharts
171
Nofe:Pricesshould exceedthe prior
high or low-not just touch the
prior high or low-to draw a new
line.
OUREXAMPLE; Sincethe range of
the first line is 135-132,the market
would either have to move under
132 or above 135 for us to draw a
new line. Session 3, at a price of
L28, sets a new low. As a result,
we make a new black line one column to the right. This line goes
from the prior low of l32to the new
low of 128.
135
132
Drawing the third line: Compare today's price to the highest high and
the lowest low of the prior two lines.
The concept here is the same as that of determining when to draw
the second line. Only when the price moves to a new high or a new low
for the move is a white or black line drawn. In our example, the market
would have to go under 128 for a black line or above 135 for a white line.
Rule 7. If the market makes a new
high by exceeding the high of the
prior lines, shift a column to the
right and draw a new white line up
to the new high.
Priorhigh
or
Rule 8. If today's price is lower
than the low of the prior lines (i.e.,
makes a new low), shift a column
to the right and draw a new black
line down to the new low price.
or
Rule 9. If prices are in the range of
the first two lines, nothing is
drawn. In this example, as long as
the price remains between 128 and
135(the prior low and high), we do
not draw a line.
L
,r,or,o*,y'.tt
ftiorlwy'
\
Newlow
- Newlow
172
The Dispaity lndex and New Pice Charts
OUR EXAMPLE: In session 4, the
price was 133. Since this was
within the price range of the prior
two lines (128-135),there is no new
line drawn. The next time a line is
drawn is session 9, when prices
moved to a new high to L39. Since
this was above the prior high (at
1.35),we shift a column to the right
and a new white line is drawn from
the top of the prior line up to 139.
The new range of lines is now from
a low of 128 to a high of 139.
The next price outside of this 128L39 range is at price 11 at 145. At
that time, a white line is drawn
from the prior 139 high to the new
high at 145.We now have two consecutive white lines. The new
range is 128-145.
(Priorhigh) 135
132
J
':,+
139
3 consecutive
whitelines
At session12, with the price at L58,
a new high is made. So, on the next
column we draw a white line from
145to 158.We now have three successive white lines. As shown in
the following discussion, this is an
important occurrence.
Drawing a line after three consecutive white or black lines: If there are
thtu
eries of three
white lines confirms a bull trend; three black lines confirm a bear trend).
Remember that this technique is called the three-Iinebreak.Its name is
derived from the fact that today's price must exceed the low of.the three
successivewhite lines, or the high of the threeconsecutive black lines, to
get a reversalline.
BreakCharts
Three-Line
Rule 10. If there are three consecutive white lines, a new white line
can be drawn whenever a new high
is made (even if this high is as little
as one tick). However, the price
must move under the lowest price
of the last three consecutive white
lines to draw a black reversal line.
Such a black reversal line is called
ablackturnaroundline.A black turnaround line is drawn from the bottom of the highest white line to the
new low price.
around line. A white turnaround
line is drawn from the top of the
lowest black line to the new high
price.
whenthishish -*J
isexceededa
new white line
can be drawn
| |
r#
rn
| |
w h e rnh i s. ' L l
is brokendraw
a blackturnaround
line
il' l.-,';1"*",^o
awhiteturnaround
line
line
I
White
turnaround
line
For the rest of this discussion, see Table 6.L and Exhibit 5.1.
By session 12 there are three consecutive white lines. As a result, the
market has to move under the low of the thfud white line (at 132)to draw
a black turnaround line. However, white lines continue to be drawn as
long as a new high is made (that is, if prices move above L58). Thus, in
our example, before a new line can be built, the market must either move
under 132 (for a black line) or above 158 (for a white line).
The next price that exceeded our 132-158 range was price 17 at 160,
a new high. Thus, a new white line is drawn from 158 to 1"50.Now, the
bottom of the last three white lines is 139. Thus, the new price range to
monitor is below 139 to get a black line and above 150 to draw a white
line.
Price L8 is a new high, as is price 19. So, two new white lines are
added. When we get to price 19 at 167, the low of the third white line is
then 158.Thus, our price range is either under 158for a black turnaround
line or above 167 for a new white line.
Price 20 is 156. This is under the lowest low of the preceding three
white lines (at 158), so we draw a black turnaround line from the bottom
of the top white line down to the new low price at 156. Becausethere
t73
174
The Disparity lndex and NeutPrice Charts
are not three white consecutive white lines (since the black line appeared), a new white line is added if a new high or low for the move is
made.
The new range to exceed is the prior high at 167 and the recent low
at 156. Price 22 makes a new high at 168. As a result, we add another
white line. This white line starts at the top of the prior black line and
goes up to the new high at 168. New highs are made (and new white
lines are added for each higher session)up until session27 at a price of
180.
At price 29 at 170,the market moved under the low of the third prior
white line (at !71), so a black turnaround line is drawn from the bottom
of the top white line down to 170. our new range is 170-180.The next
time prices move outside this range is at session35, when the market
moved down to 168. At session 36 there is another new low at 165hence another black line. We now have three consecutiveblack lines.
Becauseof this, we can only draw a white line if the price exceedsthe
high of the three previous black lines. In our example, this price would
be r77. As a result, our new price range is above \77 for a new white
turnaround line or under 155 for a new black line. At price 39 at r79, a
white turnaround line is drawn up to 179.
To summarize the method: If there are one or two black or white
lines, then a new line is added if the market reachesa new high or low.
However, if there are three consecutive white lines, the market must
move under the low of these white lines to draw a black turnaround line.
If there are three consecutiveblack lines, the high of these lines must be
exceededto draw a white turnaround line.
TRADING TECHNIQUESWITH THE THREE-LINE
BREAK CHART
White and Black Lines as Buy and Sell Signals
A seriesof alternating white and black lines, as shown in Exhibit 6.2(A),
reflects a trendless market. However, once three consecutivewhite or
black lines appear, as displayed in Exhibit 6.2(B), the market is in a trending mode. A basic trend reversal signal is produced when a turnaround
line moves under three consecutivewhite lines or above three consecutive black lines. This is shown in Exhibit 6.2(C).
The most basic method of using the three-line break is buying on a
white line and selling on a black line. Remember that if there are three
consecutivewhite (black) lines, the market has to move under (above)
the low (high) of these three lines for a black (white) line to be con-
Three-LineBreakCharts
175
bull
Confirms
trend
ffii
Confirms
bear
\(B)
(A)
Trendless
Alternatingwhite
and black lines
Ield-ggdrrng!9!
white
Threeconsecutive
or blacklines
Hioh
| |
Blackturnaround
endsprior
| | Lline
bulltrend
I
l/
I
lt
I
ll
f-
whiteturnaround
ll
,lineendsprior
a | | ,/ bearlrend
) t t t
i l I
t--l-I
I
(c)
Trend reversal with
three consecutivewhite
or black lines
EXHIBIT 5.2. (A) Alternating White
and Black Line. (B) Three Consecutive
Same-ColorLines. (C) Turnaround
Lines.
structed. Exhibit 6.3 shows buy and sell signals based on these criteria.
As can be seenfrom this example, some reversalsignalsin the three-line
break chart are sent well after the new trend has started. However, many
traders are comfortable with this insofar as they believe that it is safer to
be in for the major part of the trend rather than trying to pick a top or
bottom. The three-line break tries to accomplishthis.
The three-line break chart requires a close to confirm a turnaround
line. However, by the time this confirmation is completed, the market
may have moved substantially away from where there may have been
an attractivebuy or sell. A means around this problem is to use an intrasessionreversalsignal as the time to lightly buy or sell. Then, if desired,
add more to the position if the turnaround line is confirmed. For example,
looking at Exhibit 6.3, Bl became a turnaround line once it closed above
$31 (the high of the three prior black lines). However, by the time the
turnaround line was corroborated, the market had closed near $33. A
trader could have bought lightly on an intra-day basis on the break above
$31 and then added on the close near $33. Of course, if the market had
failed to closeabove $31, then there would have been no turnaround line
formed. In such a scenario, the prudent action would be for the intra-
176
The Disparity lndex and New PriceCharts
FORD_ WEEKLY3.LINEBREAKCHART
55
66
B = BuySignal
S = SellSignal
6n
5D
46
4E
+0
+0
JJ
35
30
30
LJ
25
Metastockby EQUISInt'l
EXHIBIT 5.3. White and Black Lines as Buy and Sell Signals,Ford-Weekly
day buyer to liquidate the long he or she had bought earlier that session.
For traders who prefer to wait for the validation of a turnaround line
formed on a close before initiating any long position, they could wait for
such a confirmation and then, over the next few sessions,hope for a
correction that would favor a buv.
Three-Line Break Charts and Candle Charts
In Chapter 4, I examined the value of monitoring the market's prevailing
trend when using the candles. Since the three-line break chart defines
whether the market is in a bull or bear trend, it can be employed as an
adjunct to candle charts. The three-line break chart can help define the
prevailing trend, and the candlescan be used as an entry mechanismto
trade in the direction of the prevailing trend. For example, if there are
three white consecutivelines, the major trend (as defined by the threeline break) is up. Basedon this, bullish candle signals could be used as
a buy signal, and bearish candle signals within this bull trend could be
Three-LineBreakCharts
177
used to cover shorts. Since candles rarely help set price targets, a white
or black turnaround line can also be used as a signal to exit a trade
originally based on a candle signal.
In Exhibit 6.4(A), a three-line break chart shows that a black turnaround line occurred after the price touched $29.50(the candle chart in
Exhibit 6.4(8) shows that there was another indication of a top with a
bearish engulfing pattern). The black turnaround line meant that the
trend had turned down. Basedon the theory that a new position should
be placed in the direction of the major trend, traders should look for a
candle signal as a time to go short in the bear trend. However, bullish
candle signals in this bear market should either be ignored or used to
cover shorts.
In this case,I will show how to use the three-linebreak chart in Exhibit
6.4(A) to fine tune trading with the candle chart in Exhibit 6.4(8).
In the candle chart in Exhibit 6.4(8), a hammer appearedon September 3. The fact that the hammer came after a falling window was an
indication that the hammer should not have been a buy signal. A few
BREAR
LILCOIrHREE_LINE
29.n
29.5
29.0
28.5
28.0
27.5
27.0
26.5
26.0
25.5
28.0
2 7 . 5(A)
27.0
26.5
26.0
25.5
tJ.3
AUG
EXHIBIT 6.4(A). Three-LineBreak Chart, Lilco-Daily
LILCO (CANDLECHART)
30.0
29.5
23.0
28.5
28.0
27.5
27,0
26.5
26.0
25.5
25.0
'93
30.0
29.5
29,0
28.5
28.0
27.5
27.0
26.5
26.0
25.5
25.0
t /
I D
MetaStockby EQUIS Int'l
EXHIBIT
6.4(8).
Candle Chart,
Lilco-Dailv
r {l 3 0 f i/ B E Y 0 t D
178
The Dispaity lndex and New Pice Charts
days after the hammer (on september 8), the market had weakened
enough to form the black turnaround line shown in Exhibit 6,.4(.{). At
that time, with a bear trend confirmed via the three-line break chart, the
rally into the window's resistancearea a few days later could be used as
a selling opportunity.
Three-Line Break Charts and Trend
Exhibit 5.5(A) is a three-line break chart and Exhibit 6.5(8) is a candle
chart. Using these Exhibits, I will show how the insights about the overall
trend provided by the three-line break charts refine trading based on
candle signals.
From Exhibit 6.5(4), the trend turned bearish beginning at the black
turnaround line of L (which formed the first week of August). It is interesting that before this black turnaround line appeared, the candle charts
gave a hint of a top with the hanging man line in |une. Throughout the
GM_ WEEKLYTHREE.LINEBREAK
++
+3
+2
++
+3
@ and@- BearMarket
@- auttMarketStarts
+2
+1
+0
+l
+0
s
s
?q
s
37
37
35
35
s
35
3+
33
32
3l
30
29
28
27
3+
33
32
3t
30
29
a
?l
J R S O N
N h J R
Metastockby EQUISInt'l
EXHIBIT 6.5(A).
Three-Line Break Chart, GM-Weekly
S O D
179
Three-LineBreakCharts
GM_ WEEKLYCANDLECHART
Harami
+5
++
+3
+2
+1
+0
<H
38
37
35
35
3+
33
JL
31
30
23
28
27
26
, [lf* ,
warning
ofrop
Upper Shadow
Illlliltr;,,
' '
tl,^L
t'il
+q
rilir
High
Wave
Candle
HangingMan
3g
v
)srwndow
Broke
Support
+3
+2
+t
+0
JU
Long
White
Candle
SupportArea
++
i,,
"il
36
35
|il"
il'ioi;."
lt,,
ill,o,+ilt
3+
t!,''
Bullish
Engutfing
Pailem
,9I JUNJULfiUDSEP
MI |\{lJ trD ' 92 FtBIlhRhPRNHYJUNJUL frF [P MI |\nJDTD
MetaStockby EQUIS Int'l
EXHIBIT 6.5(8). Candle Chart, GM-Weekly
rest of the year, the market remained in a bear mode, as shown by the
continuous series of black lines in the three-line break chart. In this environment, candle signals to sell short should be acted upon since there
was a prevailing downward trend. A long white candle during this period
gave a temporary respite to the selloff, but once the support area at the
bottom of this white candle was broken, it was a signal for lower prices.
'
At white turnaround line 2, the market transformed into a bull mode.
This means that bullish candle signals should be used as a buying opportunity. The bull trend lasted from January until the black turnaround
line in August. During this bull mode, observe how the market held
support near the midpoint of the tall white real bodies. February's highwave candle was an indication that the prior uptrend was in transition.
However, with the major trend still higher, and the long white candle
as suPPort, we could view sell-offs after the high-wave candle as corrections in a bull trend. Another tall white candle in April becamesupport
and provided a base for another upleg.
Hints of a bearish turnaround came with the harami, the hanging
33
3?
3l
s
29
n
27
26
180
TheDispaity lndexand^{surPriceCharts
man, and the long upper shadow candles during the summer of 1992,
but a bear trend was not confirmed with the threeline break chart until
the black turnaround line in August at line 3. From that point, we look
for bearish candle signals to sell the market. Note the doji in August in
Exhibit 6.5(8). This candle could be the warning of a trend reversal.
However, this doji appeared during a downtrend (as defined by the threeline break), and should not be used as a signal to buy. A few weeks later,
a falling window appeared. This was a bearish signal in a bear trend;
thus, a sell was in order.
A bullish engulfing pattern on the candle chart and a white turnaround line on the three-line break chart reflected that a new bull trend
had begun.
The new charts that I discuss in this and the next two chapters use
closing prices. Consequently, by allowing traders to use more than a line
chart, traders who use these markets are now given an extra dimension
of analysis.The three-line chart of bond yields in Exhibit 6.6 is based on
3O.YEARCASHBONDYIELD_THREE-LINE BREAK
8.0
8.0
7.5
7.5
2.0
/.0
Lower yields = Higher Prices.
Buy signals given with black
turnaroundlines.
6.5
Higher yields = Lower Prices.
Sell signalsgivenwith
white turnaroundlines
6,5
5.0
5.0
'92
'93
MetaStockby EQUISInt'l
EXHIBIT 6.6. Using Three-Line Break Charts in Markets with Only Closing Prices,
3O-YearCash Bond Yield-Weekly Close Only
Three-LineBreakCharts
closing price only. Yet, notice all the information this chart provides as
it signals reversals with the emergence of a white or black turnaround
line. Rememberthat when looking at three-line break charts in terms of
yield, the black lines are bullish since lower yields translate to higher
prices. This is why the buy signals on the chart are given with the black
turnaround line and sell signals on the white turnaround lines (a white
turnaround line means higher yields and lower prices).
Other Break Charts
Japanesetraders often adjust the sensitivity'of the three-line break chart
by changing the number of lines that the market has to break before a
turnaround line is drawn. The three-line break requires the breaking of
the last three white or black lines to get a reversal. As displayed in Exhibit
5.7(A), we see that a two-line break follows the same concept, except
that it uses two white or black lines as its reversalcriterion. Such a chart
is termed a two-line break chart. As displayed in Exhibit 6.2(B), for a
four-line break chart, the last four consecutiveand samecolor lines have
to be exceededfor a new turnaround line to be drawn.
Shorter time frame traders would usually use shorter reversal amounts
(such as a two- or three-line break). Traders and investors who are looking for major moves and are long-term oriented could use the five- or
even ten-line breaks. The most popular break chart in japan is the threeline break chart; that is why my examples are based on the three-line
break chart. However, all the trading tools used in the three-line break
charts can be applied in the same way to any other break chart.
In Exhibit 6.3, shown earlier in this chapter, I highlighted the buy and
sell signals for Ford using a three-line break chart. Using the same date
as on Exhibit 6.3, I made a two-line break chart (Exhibit 6.8) and a fiveline break chart (Exhibit 6.9). Note how the frequency of buy and sell
il'
White
tumaround
line
(A)
Two-LineBreak
Mustexceedthe highof
two consecutive
blacklines
(B)
Four-LineBreak
Mustexceedthe highof
fourconsecutive
blacklines
EXHIBIT 6.7. Two- and
Four-Line Breaks
181
182
The Disparity lndex and New PriceCharts
FORD_ WEEKLYTWO.LINEBREAKCHART
55
Brr
B = BuySignal
S = SellSignal
50
5D
B6
+5
+5
+D
Bs
s6
+D
st
Bg
35
35
B2
s3
B4
30
30
s4
B5
25
25
fet
'gz
rq?
Metastockby EQUIS Int'l
EXHIBIT 6.8. Two-Line Break Chart, Ford-Weekly
signalsincreaseswith the two-line break charts as comparedto the threeline or the five-line break charts. This is becausethe fewer the number
of lines that have to be exceededto get a turnaround line, the greaterthe
sensitivity of the chart. Consequently, a two-line break is more sensitive
and will be more volatile than a three-line break chart. A five-line break
chart will be less sensitive and have fewer reversals than a three-line
break.
Exceedingone, two, or three lines may be comparedto using a shorter
term moving average.Using the three- to five-line break charts can match
the intermediate term moving average,while the tenJine break is like a
long-term moving average. Which of these break criteria work best is
found through trial and error. It is similar to finding a moving average
that works best in vour markets.
Extra Confirmation of a Trend Reversal
SomeJapanesetraders prefer waiting for an extra confirmation of a trend
reversal, even after a turnaround line. They get this confirmation by
183
Three-LineBreakCharts
FORD-WEEKLY FIVE-LINEBREAKCHART
55
50
+5
+0
<h
30
h|Dil
N J N
N R | 1 J R S O T i l R
N R S D
MetaStockby EQUISlnt'l
EXHIBIT 6.9. Five-Line Break Chart. Ford-Weeklv
waiting for the line after a turnaround line to confirm the new trend. For
example,as shown in Exhibit 6.10, a trader could wait for the white line
after the white turnaround line before buying. (Looking back at Exhibit
5.3, traders using this concept would not have bought at B2 since there
was only a white turnaround line.)
This idea of waiting for extra confirmation would, of course, involve
a tradeoff between risk and reward. The longer a trader waits for a confirmation of a trend reversal, the greater the likelihood of being correct,
but the lower the profit potential sincemore of the new trend had already
/BuY
White
Turnaround
VT*
EreIIBIT 6.10. Waiting for Extra Confirmation
t84
The Dispaity lndex and New Price Charts
started. As expressedin the Japaneseliterature, "even though one will
get a slow start and the profits will be smaller, the false moves will be
less and the safety factor will increase." This concept of waiting for additional lines to confirm the new trend is similar to using a short-term
moving averageversus a longer term one. Those who use a short-term
moving average get aboard the new trend earlier, but whipsaws are increased.
Black Shoe, White and Black Suits, and a Neck
As displayed in Exhibit 5.1'1.,a short black line is sometimescalled ablack
shoefor the obvious reason that such a line looks like a black shoe. A
white turnaround line (a white line that surpassesthe prior three black
lines) is sometimeslikened to a white suit.
The short white line that comes immediately after a white turnaround
line (i.e., a white suit) is called a necksince it looks like a neck coming
out of the white suit.
There is a Japaneseexpressionregarding the three-line break: "Buy
when the neck emergesfrom the white suit with black shoes." The reason for this expressionis as follows:
1,. The small black line (the shoe) shows that the selling pressure may
be easing since the move towards lower prices is becoming more lethargic.
2 . The white turnaround line is a bullish reversal signal.
3. The neck is the buy signal. The neck's short white line is viewed as
the market taking a breather after its prior advance (i.e., after the prior
white turnaround line). A short white line could also reflect that the
bears may have not yet covered their shorts (these who sold during
the series of black lines that came before the white turnaround line).
This could mean higher prices once these shorts decide to cover. Since
the neck is also the second white line after the white turnaround line,
(Buy Signal)
EXHIBIT 6.11. Black Shoe, White Suit, and a Neck
Black
Shoe
Three-LineBreakCharts
it servesas extra bullish confirmation. As discussedpreviously, some
traders prefer waiting for the second white line as a buy signal.
In Exhibit 6.12, I show an example of a neck, a black suit, and a black
shoe. This black turnaround line is sometimes called a blacksuit. The
small black line after the black suit is the sell signal.
There is a saying that a trader should "sell if the black shoe comes
out of a black suit after a neck." The meaning of this expressionis explained below:
1. The diminutive real body at the top of the rally (i.e., the neck) shows
that either the buying pressureis slackeningor the selling pressureis
enough to slow the bulls' advance.
2. The black turnaround line (the black suit) is a reversalsignal that tells
us that the bears have gained control.
3. The small black line (the shoe) means that the market is weak, but not
oversold. Also, it shows that the buyers on the way up (during the
series of white lines before the black turnaround line) may not have
liquidated as yet. This could mean that there is still more selling likely
to come when these existing longs decide to liquidate. The black shoe
after the black turnaround line also provides bearish confirmation
for these who prefer to wait for a second black line to get a reversal
signal.
I show in Exhibit 6.T3a bottom reversal signal in Septemberand into
October that is based on the saying, "buy when the neck emergesfrom
a white suit with black shoes." The small black line, i.e., a black shoe,
emerged near $42 in September. The white suit (another name for the
white turnaround line) came after this black shoe. Following the black
shoe, a white line, becauseof its small size, was a neck, and hence a buy
signal. A top reversalpattern, grounded on the dictum, "sell when black
shoesare under a black suit after a neck," appearsat the price peak near
$59. The small white line after the rally was a neck, the black turnaround
line after this neck was a black suit, and the confirmation of a sell came
with the small black shoe.
Neck
Black
../sun
EXHIBIT 6.U1. Neck, Black Suit, and a Black Shoe
185
186
The Disparity lndex and New Pice Charts
MEXICOTELEPHONETHREE-LINEBREAK
59
58
57
56
55
59
58
57
56
55
5+
5+
53
52
5l
50
53
52
5t
+9
+B
+7
+6
+5
+9
+8
+7
+6
s)
4E
++
+3
++
+3
+2
+7
MetaStockby EQUIS Int'l
EXHIBIT 6.13. Buy When the Neck Emerges from a White Suit with Black Shoes;
Sell When Black Shoes Are Under a Black Suit After a Neck, Mexico TelephoneDaily
Record Sessions and Three-Line Break Charts
]ust as record sessionsare important in candle charting, so this technique
is useful for some of the new charting techniques such as the three-line
break chart, and as we'll see later, kagi charts. When there are 8 to L0
consecutive or almost consecutive white lines, the market is viewed as
being overextended to the upside. When there are 8 to 10 black lines
during a downtrend, the market becomes vulnerable to a bounce.
One of my important sources of information has been the Nippon
Technical Analysis Association. I sent the NTAA member a copy of Exhibit 6.14 with some questions about the three-line break chart. This
gentleman graciously addressed my questions, and he also placed the
numbers shown on each of the falling black lines. He did this to illustrate
how he uses record session counts as one of the techniques for trading
with the three-line break chart. We seein this chart that when the market
Three-LineBreakCharts
187
DELTA_ THREE.LINEBREAK
75
75
7D
7D
65
65
50
60
55
55
50
50
S O
N
J
R 11J
A
S
O N
DFA 11
Metastockby EQUIS Int,l
EXHIBIT 5.14. Three-LineBreak Chart Record sessions,Delta-weekly
reached eight record sessionslow, prices bounced. Another interesting
aspectof this chart was that the NTAA member also placed an X and a
Y on the chart at the price peaks shown. He mentioned that this area
was resistanceon any rebounds. Although it is not shown on this chart,
a rally in late 1993failed near this $60 resistancearea and fell to near 945.
Thus, we can seethat using an obvious resistancearea, such as the dual
highs near $60, should be used with three line-break charts.
Western Patterns and Three-Line Break Charts
Techniquesthat apply to candle or bar charts, such as support and resistanceor double tops and trendlines, also apply to three-line break
charts.
The uptrend support line and the resistance zone in the $49.50 area
188
The Dispaity lndex and New Pice Charts
in Exhibit 5.L5 illustrate how a trendline and a resistancearea can be
defined on a three-line break chart just as easily as on a candle chart.
A double top or tweezers top is also sometimescalled a two-paired
chimney. In Exhibit 6.16, we see an example of such a pattern with the
dual highs at A and B near $74.
Exhibit 6.17 shows how trendlines on the three-line break chart can
be used as effectively as on a traditional bar chart. The breaking of the
uptrending support lines signaling that the uptrend was in the process
of changing. In addition this chart also displays that the bulls were losing
force since each of the major price peaks at shoulders 1, 2 and 3 were
progressivelylower.
Exhibit 6.18 disptays some of the tools that can be used to trade with
the three-line break chart. A downward sloping resistance line was
pierced in early 1993.Also of interest in this chart is the prior resistance
area from mid-1992 near $68 (called old resistance on the chart) that
PACIFICTELE THREE.LINEBREAK
%
55
5+
53
52
51
50
+9
+8
+7
+5
+5
55
55
R4
53
52
cl
50
+9
+8
+7
+6
+5
++
++
+3
+2
+l
+0
+3
+2
+1
+0
Metastock
by EQUISInt'l
EXHIBIT 6.15.
Telephone-Daily
Trendlines and Resistance with Three-Line Break Charts, Pacific
BREAK
PFIZER- THREE.LINE
75
71
75
71
(J
f5
72
7l
/t
59
58
7l
70
69
68
6/
6(
65
65
61
53
62
bb
bl
ol
50
59
rU
57
50
59
58
57
?n
tu
65
61
63
62
MetastockbYEQUISInt'l
EXHIBIT 6.L6. Double Top with Three-Line Break Charts
BREAK
PFIZER- THREE.LINE
83
82
81
80
B3
82
81
80
7g
7B
77
76
75
71
n
/J
78
77
76
75
7q
73
/1
n
7l
70
59
58
67
66
71
70
69
58
b/
bb
JUL
AI-JG
SIP MT
ISJ
OtC
Jtr{
Metastockby EOUISlnt'l
EXHIBIT 6.17 Three-Line Break Chart Trendlines, Pfizer-Daily
189
190
The Dispaity Index and New Price Charts
MOBIL- THREE.LINE
BREAK
n
n
78
77
76
75
7p,
77
76
75
7+
7+
73
72
7l
7D
59
58
67
56
65
73
72
7l
7D
59
58
67
65
55
5+
5+
bJ
63
62
5l
50
bt
5l
5D
59
58
Eq
6R
Metastockby EQUIS Int'l
EXHIBIT 6.18. ClassicWestern Techniqueson a Three-LineBreak Chart, MobilDailv
becamea new support area. This support areawas confirmed by a white
turnaround line.
Note
IEquity International
Magazine,July/August 1991.
PRACTICE SESSION FOR THE
THREE-LINE BREAK CHART
Frt
I o reinforce your understanding of the three-line break chart, use the
closing prices in Table 6.2, on the following page, to construct a threeline break chart. The scaleon the vertical axis should be set up from $23
to $30. You may photocopy and use the supplied graph shown on page
L93or draw a rough scaleon plain paper. The exact size of the white or
black lines is not important. The meaningful aspectof this practice is to
use your chart as a gauge to see how well you understand when a new
white or black line should be drawn.
After you construct the chart, compare it to Table 6.3 and Exhibit 6.19
(on the pagesfollowing the exercise)where the actual chart and the days
on which new lines were constructed are shown.
t91
192
The Disparity Index and New Pice Charts
TABTE 6.2 Data for Three-Line Break Chart practice Session
Date
Closing Price
Date
Closing Price
02118t94
02t22t94
02t23t94
02t24t94
02t25t94
02128t94
03t01t94
03t02t94
03t03t94
03tMt94
03t07t94
03108t94
03109t94
03t10t94
031l'u94
03t14t94
03115t94
03116t94
03t17t94
03t18t94
03121194
03t22t94
03t23t94
03124194
03125t94
03t28t94
03129194
03130t94
03t31t94
04t04t94
04t05t94
04106194
04107194
04t08t94
04111,t94
04112t94
Ml13t94
04t14t94
04115194
04118194
04119194
04t20t94
04t21t94
04122t94
04125t94
04t26t94
04t28t94
25.156
25.250
26.375
26.500
26.875
27.750
27.375
27.375
27.125
28.750
28.125
27.875
28.250
28.250
28.375
28.250
27.500
28.500
29.125
29.250
28.750
28.500
28.625
28.250
27.125
27.500
26.250
25.875
26.500
26.375
27.375
26.375
26.062
25.750
26.125
25.875
2s.750
25.250
24.375
24.000
23.625
23.875
26.500
26.750
27.375
27.375
26.875
04t29t94
05102t94
05t03t94
0s104t94
05105194
05106t94
05t09t94
05110t94
05111194
0s112t94
05t13t94
05t16t94
05117194
05118t94
05119194
05120t94
05t23t94
05t24t94
05125t94
05126194
05127t94
05t31t94
06101"194
06t02t94
06103t94
06106t94
06t07t94
06t08t94
06109t94
06110194
06113194
06t14t94
06115194
06t16t94
06t17t94
06120t94
06t21t94
06122194
06t23t94
06124194
06127t94
06t28t94
06t29t94
06130t94
07101t94
07t05t94
27.000
26.875
26.525
27.687
28.000
27.125
25.875
27.250
25.500
24.875
24.875
24.125
25.000
26.250
27.375
27.500
28.000
27.625
27.125
26.250
26.250
26.250
26.375
26.625
27.375
28.500
27.250
26.250
26.500
26.125
25.750
26.000
26.625
26.125
26.250
25.750
25.375
25.375
24.7s0
23.500
24.062
23.250
23.500
24.125
24.625
24.625
193
194
The Disparity lndex and New PriceCharts
TABLE 6.3 Data for Answers to Three-Line Break Chart practice session.
Numbers in ParenthesesRefer to Line Numbers in Exhibit 6.19
Date
Closing price
Date
Closing Price
02118t94
02t22t94
02t23t94
02t24t94
02125t94
02128t94
03t01t94
03102t94
03103t94
03104194
03t07t94
03108t94
03t09t94
03110t94
0311tt94
03114t94
03t15t94
03t16t94
03t17t94
03t18t94
03t21t94
03t22t94
03t23t94
03124t94
03t25t94
03t28t94
03t29t94
03t30t94
03t31,t94
04t04t94
04t05t94
04106t94
04107194
04108194
041l1t94
04112194
04t13t94
04114t94
04t15t94
04t18t94
04t19t94
04t20t94
04t21,t94
04t22t94
04125t94
04126t94
04t28t94
25.156
2s.250(1)
26.37s(2)
25.500(3)
26.875(4)
27.7s0(5)
27.375
27.375
27.125
28.750(6)
28.125
27.875
28.250
28.250
28.375
28.250
27.500
28.500
2e.125(7)
2e.250(8)
28.7s0
28.500
28.625
28.250
04t29t94
05t02t94
05t03t94
05t04t94
05t05t94
05t06t94
05109194
05110t94
05111194
05t12t94
05t13t94
05t16t94
05t17t94
05t18t94
05t19t94
05t20t94
05t23t94
05t24t94
05t25t94
05t26t94
0st27t94
05131.t94
06101194
06102194
06t03t94
06106t94
06t07t94
06108t94
06109t94
06t10t94
06113194
06114194
06t15t94
06116194
06117t94
06120t94
06t21t94
06122194
06123t94
06t24t94
06t27t94
06t28t94
06t29t94
06t30t94
07t0Lt94
07105194
27.000
26.875
26.625
27.687(20)
28.000(21)
27.125
25.875(22)
27.250
25.500(23)
24.875(24)
24.875
24.125(2s)
25.000
26.2s0(26)
27.37s(27)
27.500(28)
28.000(2e)
27.625
27.125
26.250
26.250
26.250
26.375
26.625
27.375
28.500(30)
27.2s0(31)
26.250(32)
26.500
26.12s(33)
25.750(U)
26.000
26.625
26.125
26.250
25.750
25.375(35)
25.375
24.750(36)
23.500(37)
24.062
23.250(38)
23.500
24.125
24.625
24.625
27.12s(e)
27.500
26.250(10)
2s.87s(11)
26.500
26.375
27.375
26.375
26.062
2s.7s0(12)
26.125
25.875
25.750
25.2s0(13)
24.375(14)
24.000(1s)
23.62s(16)
23.875
26.500(17)
26.750(18)
27.37s(1e)
z/ .J/ 3
26.875
O I
O)
c\
S )
CO
c\
C
]
L
f )
r\
c!
@
c\
O
L
D\
c\
O
O
\O
c!
L
f )
\.o
c\t
O I
tf)
c\,1
lf
co
.
c )
lJ)
c\
C ]
+(\
L
f )
<c\J
IE
I
F
aa
c!
f-
(t)
IE
(\l
(r)
I6
o
(r)
Y
z.
=
F-)
O)
C\I
UJ
c.
I
qJ
ol -t-F
c0
UJ
c
(ol
z
c
-
(!r
=
d
uJ
CE
I
F
I
I
$l
C!
rN
T
F
rs
(?)
9.
a
ut
IH
-o
J
Q
6
( v r'
I
Y
O
(D
F
l
c
=
l
F
I
II
o
J -t
I
#F
I
l--
CD
c\
L
f
)
6
c\
o
L
o
CO
c\,t
)(I
6
s
d
a
c
!.
(6
U
J(E
OJ
l-a
d
c
l
Fc\
r
-
(
l'c\l
c)
c
=
t l
I
I
q)
rL
o
I
I
II
'ol
I I
T:
I9
t)
_l
oI
-
-
!
I
col I
+
l..L
(!
o
ll roL f
l
o
U)
Fr
lo..
-
)
\O
c!
o
K
F
l LJ?
)
\O
c\
c
)
L.)
c\
L
(
)
Lf)
c\
o\
(
f
L
c!
f
\0
F
lo
)
3c!
Ct
c\t
F
xlrl
195
CHAPTER7
RENKO CHARTS
&€ AE NTffiUATNA
"Considerthe Pastand You WilI Know the Future"
Tn" renko chart, shown in Exhibit 7.'1,,is also termed a neri, training,
or zigzag chart. The renko charts looks similar to the three-bar break
chart since they both have lines that look like blocks. The individual
blocks that form the renko chart are sometimes referred to as bricks(the
"Ienga," which is the
Japaneseword for
term renko may come from
bricks).
As we saw in Chapter 6, in a three-bar break chart, another line is
added as the market moves in the direction of the prevailing trend, no
matter how small the move. For example, if the market closed today by
even one tick higher, a new white line would be added to the three-line
break chart if the prior line was white.
However, for a renko chart, a line is drawn in the direction of the
prior move only if a fixed amount has been exceeded. For example, if
iher" is a white brick on the renko chart, the market has to advance by
a predetermined fixed amount before a new white brick can be drawn.
Another difference between the renko and three-line break chart is
that the lines in the three-line break chart are of different sizes, while the
bricks in a renko chart are all the same size.
197
198
The Dispaity lndex and New Price Charts
(27)
180
(38)
(26)
175
170
(23)
165
(1e)
(2e)
(36)
(17)
160
155
150
145
(11)
140
135 (1)
130
125
EXHIBIT 7.1. Exampleof Five-PointRenko Chart Basedon Pricesfrom Table 7.1
RenkoCharts
CONSTRUCTION OF RENKO CHARTS
Table 7.1 shows the price data used to draw the exampleof the renko
chart in Exhibit 7.1.
The renko chart uses closing prices. The first step is to choosea price
range unit. This price range point is the minimum amount the market
must move before a renko brick is drawn. The price range point also
servesto set the height of the brick. Thus, a five-point renko chart would
have bricks that are five points tall. This will become clear after I go
through the following detailed example.An important aspectof the renko
chart is that rising lines are denoted by equal size white bricks and falling
lines are denoted by equal size black bricks. Thus, no matter how large
the move, it is shown on the renko chart as equal sized bricks. For example in a five-point renko chart, a 20-point rally is displayed as four
five-point-high renko bricks.
TABLE 7.1 Data for the Five-Unit Renko Chart Displayed in
Exhibit 7.1
Session
1,
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Closing Price
Session
Closing Price
baseprice 135
132<
128r(1)
133<
130<
130<
132<
134<
139<
137<
14sr(2)
158r(2)
147<
143r(1)
150<
149<
150r(2)
164<
167t(1)
156<
21,
22
23
24
25
26
27
28
29
30
31
32
33
165<
168<
171"r(1)
173<
169<
1771(1)
180r(1)
176<
170i(1)
175<
179<
173<
170<
170<
168<
165J(1)
17't<
1751(1)
179<
175<
u
35
36
37
38
39
40
Legend
(<)-Move is less than fixed amount. No brick is drawn.
l-Where the price exceeds the prior brick by the fixed amount.
( ) Shows how many white bricks are drawn.
l-Where the price moves under the prior brick by the fixed amount.
( ) Shows how many black bricks are drawn.
199
200
The Dispaity lndex and New PriceCharts
OUR EXAMPIE: We will use a fivepoint renko chart. This means each
brick will be five points high. Our
base, or starting price, is 135.
Drawing the first brick: Compare the base price to the current close.
Rule 1. If the market rallies from
the base price:
A white brick (or a series of white
bricks) is drawn only if the market
moves above the base price by the
fixed amount or more. Thus, iI
there is a base price of 100 and we
are using a five-point renko chart,
then the market has to move up to
at least 105 before a white brick is
drawn.
Mustascendby at least
the
chosenpricerange
,/
ros;f
t l
toolJ 4"." pri."
Nofe:Prices should touch or exceed
the prior high or low by the point
amount for a brick to be drawn.
This is different from the three-line
break chart, where the price should
exceed the prior high or low.
If the market moves up by more
than what would be required to
draw one brick, but less than
needed to draw two bricks, only
one brick is drawn. For example,
in a five-point renko chart, if the
base price is 100 and the market
moves to 107,then one white renko
brick is drawn from the base price
of 100 up to 105. The rest of the
move-from 105 to 107-is not
shown on the renko chart. However, if the market had moved up
to 110, then there would be two
five-point-tall white bricks. A move
to 112 would also have two white
bricks. The portion of the rally from
110to 112 would not show.
or
Rule 2. If the market falls from the
baseprice:
tttfll
1o7 \ Thisis not
rosp/snown
[f-on"
,oo
0,,.*
7 pointrallyfrom
100 to 107 in a five
unit renko chart
bricks
,: ilirwo
10 point rally
in a five unit
reoko chart
RenkoCharts
Draw a black brick only when the
price declinesfrom the baseby the
fixed amount or more (in this example, five points). Thus, with a
base price of L00, the market has to
decline to 95 or lower before a black
brick is drawn. The first black brick
startsfrom the baseprice and goes
down by the fixed point amount.
If the decline is more than the
fixed point, but less than twice the
minimum amount, then draw only
one black brick. As an example, a
decline from a base price of 100
down to 92 on a renko chart would
have one five-point black brick
from 100to 95.
',.1.*-***
amountor more
t*
la
nr,l
rhisporrion
is
notshown
8 pointdecline
from100to 92
.1
However. if there was a decline
of, for example, 13 points, then two
black bricks would be drawn. If the
market fell by 15 points, there
would be three black bricks, with
each brick in a separatecolumn.
or
Rule 3. If the market moves up or
down by less than the minimum
fixed point (in this case, five
points), then no bricks are drawn.
For example, for a five-point chart
and a base price of L00, until the
market goes up to L05 or down to
95, there is no brick shown.
OUR EXAMPLE: In Table 7.1, the
base price is at 135. Since this example is a five-point renko chart,
to draw a black brick the market
has to move to L30 or lower (i.e.,
five points under the 135 base
price). For a white brick, the market would have to ascendto 140or
higher (i.e., five points above the
135 base price). At session 2, the
market fell to 132 or three points
(135to 132). This was not enough
to draw a black brick since it was
less than the minimum figb points
needed. By session 3, prices had
:l I
13 pointdecline
from100to 87
15 pointdecline
from100to 85
1,.t,-..-;
201
202
The Dispaity lndex and New Pice Charts
moved down to L28. This was now
seven points under the base price
of 135. This seven-point fall is
enough to draw one black brick.
Thus, at session 3, we draw one
five-point black brick from 135 to
130.
Drawing the next brick: Compare today's close with the high and low of
the last brick.
Rule 4. If today's closeis above the
top of the last brick (whether that
brick is white or black) by the point
amount or more, move a column
to the right and draw one or more
white equal height bricks. The brick
starts from the high of the prior
brick. Thus, if the top of the latest
brick was at L00, in our five-point
renko chart, the market would
have to move to L05 or higher for
a white brick to be drawn. This
white brick would go from 100 to
105.If the market goesto 113,then
there would be two white bricks,
with each brick in a separate
column.
New brick added
High of last
brick = 100
lf priorbrick
is white
llH*,;;#"'
95
lf priorbrick
is black
or
Rule 5. If today's price closesunder the bottom of the last brick
(white or black) by the minimum
amount or more, then move a column to the right and draw one or
more black bricks with each equal
size brick in its own column. This
means that if the bottom of the last
brick is 95, the market would have
to go to at least 90 before a black
brick is drawn. Such a brick would
go from the low of the previous
brick at 95 down to 90.
or
Rule 5. If the price is under the
high or abovethe bottom of the last
brick, then nothing is drawn.
'*
or
[l*- Bottom
.,""t
="'':,1- "
ftl*
,,illno
B:ffr
lfpriorbrick
iswhite
tu
I no
[ool:Jf'o*
RenkoCharts
OUR EXAMPLE: The high of the
first brick is 135 and the low is 130.
To draw a new brick in our fivepoint renko chart, the price has to
move to 140(i.e., five points above
the 135 high) or higher for a white
brick, or 125(i.e., five points under
the 130 low) or lower for a black
brick. If the market remains under
140 or above L25, then nothing is
drawn.
The next time the market reached
either L40or higher or 125or lower
was at session 11, with a price of
145. At that time, we drew two
five-point white bricks from the
prior high of 135 to the new high
at 145.
Fora whitebrick
need140or higher
135
Currentpricerange
130
.
Fora blackbrick
need125or lower
;l*(sessionll)
(Base
Price)
tl
l:: I *,."".,
Drawing the next bricks: Using the data from Table 7.1, draw the rest of
the chart shown in Exhibit 7.1,by the same processjust discussed.For
example, let's look at session 12 on Table 7.1. At that sessionthe price
was L58. The prior high, at session1L, was 145. we thus draw two fivepoint white bricks from the high of the prior renko brick at 145 up to 155
(the rest of the move from 155 to 158 is not shown on the renko chart).
with the high of the last brick (at session 12) at 155 and the low of that
brick at L50, we need the market to move either to 160 or higher for a
white brick, or 145 or under for a black brick. Thus, at session 14 the
market fell enough (to 143) to draw a new black brick down to 145.
TRADING TECHNIQUES WITH RENKO CHARTS
Unlike the varied trading techniques applicable with three-line break
charts and kagi charts (discussedin the next chapter), the renko charts
are more limited. The only trend reversal signals with renko charts are
with the emergence of a bullish white brick or bearish black brick. Buv
and sell signalsbased on this technique are shown in Exhibit 7.2.
As shown in that exhibit, buy signals (shown by the letter B) are
generated with the appearance of a white brick. Sell signals (shown by
S) are produced when a black brick appears. since the renko chart is a
trend-following technique, there will be times when the market is in a
lateral trading band. In such an environment there may be whipsaws
(see B1-S1,Be-Ss,and Ba-Sf. However, the expectation with a trendfollowing technique such as this is that it allows traders to ride on the
203
204
The Disparity lndex and New PriceCharts
INTEL#2 RENKO
70
70
55
55
50
50
55
55
50
50
45
45
10
40
35
35
30
30
75
25
20
'92
20
'33
MetaStockby EQUIS Int'l
EXHIBIT 7.2. Basic Buy and Sell Signals Generated with a Renko Chart, Intel-$2
Renko, Daily
major portion of the trend. This is shown by the buy and sell signals
produced at 82-52,Bs-Ss,and B5-Su.
Exhibit 7.3 shows the advantagesoffered by a renko chart in a trending market. The buy signals come with the arrival of a white renko brick
and the sell signals with a black brick. Only when the market shifted into
a lateral range at L did the renko chart induce in and out trading.
In Exhibit 7.4 we take a longer term bond chart to seehow the renko
chart could be used as a technical tool to buy. When the market shifts
into a neutral band, as it did at areas1 and 2 on the chart, then the renko
chart may induce more volatile trading. However, this chart did allow a
long to enter and capture the bulk of the 1993 rally while keeping him
out of the market for most of the late 1993- earlv 1994selloff.
GOLD_ WEEKLY(3.PTRENKO)
{05
{05
{m
{m
3$
3S
3S
3S
385
s5
s0
380
375
3/0
355
360
355
350
3{5
3{0
335
330
375
320
365
350
355
m
3{5
310
335
3A
Metastock by EQUIS Inl'l
EXHIBIT 7.3. Basic Buy and Sell Signals, Gold-Weekly-$3
Renko
BONDS- WEEKLY_ 24132RENKO
122
t22
l2l
120
119
ll8
ttl
r20
ils
il8
lt7
il6
lt5
ltl
ll3
lt2
llr
ll0
n7
116
115
1l{
ttJ
112
111
110
109
lm
107
105
r05
t0{
r03
102
lm
108
107
106
105
r01
103
102
MetaStod< by EQUIS Int'l
EXHIBIT 7.4. Bond Futures-Weekly-z4l32
renko Buying Long
205
PRACTICE SESSION FOR THE
RENKO CHART
T T
LJsing the data from Table 7.2 (on the following page), build a $1 renko
chart. The scaleshould be from $40 to $50. You may photocopy and use
the supplied graph on page 209or use plain paper. When finished, compare your answer to that shown in Exhibit 7.5 and Table 7.3 found on
the following pages.
207
208
The Disparity lndex and New Pice Charts
TABLE 7.2 Data for Construction of $1"Renko Practice Chart
Date
Close
Date
Close
03t24t94
03t25t94
03t28t94
03t29t94
03t30t94
03131t94
04t04t94
04105194
04t06t94
04107194
04t08t94
04111194
04112194
04113t94
04t14t94
04115194
04t18t94
04t19t94
04t20t94
04t21t94
04122194
04125194
04t26t94
04t28t94
04129194
05t02t94
05t03t94
0s104194
05105194
05t06t94
05t09t94
05t10t94
05t11,t94
05112194
05113194
47.625
47.750
47.500
46.125
45.125
45.250
44.500
45.000
45.250
M.875
M.250
43.375
42.500
42.750
42.000
41,.375
40.000
39.875
40.125
41.250
42.250
42.625
43.37s
45.250
47.500
47.625
46.500
46.125
46.250
45.750
45.125
45.250
43.500
43.525
M.125
05116194
05t17t94
05t18t94
05119194
05t20t94
05t23t94
05t24t94
05125194
05t26t94
05t27t94
05t31,t94
06101.194
06t02t94
06t03t94
06t06t94
06107t94
06108194
06t09t94
06110194
06113194
06114194
06115194
06t1,6t94
06t17t94
06t20t94
06121,194
06122194
06t23t94
06t24t94
06127194
06t28t94
06129194
06t30t94
07t01,t94
07t05t94
43.750
44.000
44.875
44.625
45.250
45.250
45.250
45.125
45.500
45.625W7
45.s00
45.625
45.000
u.750
44.875
45.250
45.250
45.125
45.125
45.625
45.500
45.375
46.500
47.000
46.125
45.125
45.375
45.875
45.250
45.250
4.625
45.125'
45.250
46.125
46.750
209
2T0
The Dispaity lndex and NeutPice Charts
TABLE 7.3 Data for Answers to Renko Chart Practice Session Shown in
Exhibit 7.5.W : White Brick, B : Black Brick.
Date
Close
Date
03t24t94
03t25t94
03t28t94
03t29t94
03t30t94
0313'il94
04t04t94
04t05t94
Mt06t94
04t07t94
04t08t94
04117194
04112194
04t13t94
04t14t94
04t15t94
04.t18t94
04t19t94
04t20t94
04121.194
04t22t94
04125194
04126194
Mt28t94
Mt29t94
05102194
05103194
05104194
05105194
05t06t94
05t0pt94
05110194
05111194
05112194
05t73t94
47.625 base price
47.750
47.500
46.125 81
45.125 82
45.250
414.50083
45.000
45.250
M.875
M.250
43.375 84
42.500 85
42.750
42.000
4't.37586
40.000 87
39.875
40.125
41.250
42.2s0
42.625 Wl
43.375
45.250 W2 and W3
47.500 Wa and W5
47.625 W6
46.500
46.125
M.250
45.750
45.125 88
45.250
43.500 Be and B1s
43.525
M.125
05116194
05117194
05118194
05t19t94
05120194
05t23t94
05124194
05125194
05126194
05t27t94
05t37t94
06101t94
06t02t94
06t03t94
06t06t94
06t07t94
06108194
06lwl94
06t10t94
06113194
06t14t94
06t15t94
06116194
06t17t94
06120194
06t21t94
06122194
06t23t94
06t24t94
06t27t94
06t28t94
06129194
06t30t94
07t01,t94
07t05t94
Close
43.750
44.000'
M.875
M.625
45.250
45.250
45.250
45.125
45.s00
45.625W7
45.500
45.625
4s.000
M.750
M.875
45.250
45.250
45.125
45.125
45.625
45.s00
45.375
46.500
47.000w8
46.125
45.125
45.375
45.875
45.250
45.250
M.625 Bn
45.125
4s.250
46.12s
46.750 We
=
I
r-)
o
Y
=
'..)
z
t!
tr
6
I
I
><tr
=
J
[!
c
o
o
o
o
o
(U
L
ct
.Y
c)_
<tr
EXHIBIT 7.5. Delta-$1 renko
211
CHAPTER8
KAGI CHARTS
X rUt{E0t
"Like the Right Arm Helping
the Left"
FF
I he Kagi chart is thought to have been createdaround the time that the
Japanesestock market started trading in the 1870s.A kagi chart is shown
in Exhibit 8.1. The name kagi chart comesfrom the ]apaneseword "kagi,"
which was an old fashioned key that had an L-shaped head. This is the
reasonthat kagi charts are also calledkey chartsby some]apanese.Other
names for the kagi chart include the price range chart, the hook chart,
the delta chart, and the string chart.
A fapanesebook on kagi stated, ". . . just as candle charts are superior
to bar charts, so key charts are superior to point and figure charts"l I am
not enough of an expert on point and figure charts to agree or disagree
with that statement. \tvhat I can state with certainty, however, is that
kagi charts will open new and rich methods of analysis that are unavailable with any other chart.
The basic premise of the kagi chart is that the thickness and the direction of the kagi lines are dependent on the market's action. If the
market continues to move in the direction of the prior kagi line, that line
is extended. However, if the market reversesby a predetermined amount,
a new kagi line is drawn in the next column in the opposite direction.
An interesting aspect of the kagi chart is that when prices penetrate a
prior low or high, the thickness of the kagi line changes. The thick kagi
line is called a yang line and the thin kagi line is called a yin line. Later
in this chapter, I will detail how to construct and interpret the yang and
yin lines. The short horizontal line on the kagi chart is labeled the inflection line.
2L3
214
The Disparity lndex and New Price Charts
180
40
37
170
35
19
22
18
17
21 30
160
20-ts
13
150
11
14
140
4
Base
Price
130
3
EXHIBIT 8.L. Exampleof a Kagi Chart Using Table 8.1
KagiCharts
CONSTRUCTIONOF KAGI CHARTS
Kagi charts are most commonly based on closing prices. Before starting
the kagi chart, a turnaround (i.e., or reversal) amount must be chosen.
This is the minimum price movement that is neededbefore a new reversal
line can be drawn in the next column. For instance, if the turnaround
amount is S3, and if there is a rising line, today's price must closelower
by at least $3 before a falling turnaround line can be drawn. This will be
becomeclear when I get into more detail about the construction of the
kagi chart. For kagi charts, the turnaround amount can be touched or
exceededfor a reversal line to be drawn.
OUR EXAMPLE: The starting
price, as shown at session 1 in
Table 8.L, is 135. The turnaround amount in this example
will be four points.
TABLE 8.1 Data Used for Four-Point Kagi Chart in Exhibit 8.1
Session
1.
2
J
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Closing Price
Session
135baseprice
132<
1281
1331
130<
129tr
127t
134*(prior high-133)
1391
137<
1451
1581
1,47tr
1431
1501
149<
1601
1641
1671
156J
21
22
23
24
25
26
27
28
29
30
31
32
33
u
35
36
5/
38
39
40
Closing Price
1651
1681
1711
1731
1691
1nI
1801
1761
170t
L65* (prior low-169)
1691
1731
170<
170<
168J
165J
1711
L75* (prior high-173)
1791
175t
Legend
(<)-Move is less than reversal amount. No line is drawn.
*-Where the price exceedsthe prior high or low (line
changes thickness).
1 l-Up and down arrows-show direction of the current line on Exhibit 8.1.
215
216
The Disparity lndex and New Pice Charts
Drawing the first line: Compare today's price to the base price.
Rule 1. If today's price is higher
than the base price by the turnaround amount or more (in our example, this would mean four or
more points from the starting
price), then a thick (yang) line is
drawn from the starting price to the
new high closing price.
Nofe: To draw a line, the change in
price should be the same or greater
than the turnaround amount.
Rule 2. If today's price is lower
than the base price by the predetermined turnaround amount or
more, then draw a thin (yin) line
from the starting price down to today's price.
Rule 3. If the difference between
the current close and the base price
is less than the minimum turnaround amount (in our case, four
points), no line is drawn
OUREXAMPLE: The starting price
is 135. During the next session, the
market moved down to132. This is
less than the predetermined turnaround amount of four points, so
we cannot yet draw a line. At session 3, the price had fallen to 128.
Now, the market had dropped
more than the four points needed
to draw the first line (from session
1 to session 3, prices fell seven
points). Thus, we draw a thin yin
line ftecause the market moved
down) from the starting price of 135
down to 128.
Today'sprice
Baseprice
Baseprice
Today'sprice
135 (Base price)
128(Session
3)
Drawing the second line: Compare today's price to the tip (i.e., the bottom or the top) of the last kagi line. In our example, the bottom of the
line is L28 and the top is 135, so we would compare the more current
price to 135 and L28.
IGgi Charts
Rule 4. if the price continues in the
same direction as the prior line, the
line is extended in the same direction, no matter how small the
move. Thus, in our example, if the
price fell to \27, we would then extend the yin line down from L28 to
127. However, if the first line is a
thick yang line (instead of yin line),
the thick line would then be extended higher if there is a new high
close.
217
Newhighclose
Priorclose
Prior close
New low close
Yin line
Yangline
or
Rule 5. If the market changes direction by the turnaround amount
or more (this could take a number
of sessions),then we go the next
column, draw a short horizontal
line (called an inflectionline) to the
next column and draw a vertical
line in the new direction to the new
price. In our example, the low of
the last line was at 128. Since we
need a four-point turnaround, the
market would have to close at 132
or higher to draw a new line in the
opposite direction.
lnflectionline
l i x
'T
Nole:Theselinescan be thickor thin.The
movefromx to y mustbe equalto or
greaterthanchosenturnaroundamount.
(
lnflection line
or
Rule 6. If the market moves in the
opposite direction to the preceding
trend by less than the turnaround
amount, then that session is ignored.
OUR EXAMPLE: With the bottom
of the last kagi line at L28, we compare the price at session 4 to that
at 128. With session 4 at 133, it
means prices had risen by five
points (from 128 to 133). This was
enough of a move (since the turnaround amount was four points) to
draw a new line in the opposite direction to the prior line. As a result, we move a column to the right
by drawing a short horizontal line
(the inflection line) and then draw
a line going up. This line starts at
L28 and goes up to 133.
(Baseprice)
135I
| |
il
t.. (Session4)
.',,U
(Session3)
218
The Disparity lndex anQNew PriceCharts
Drawing the third line: We again compare the most recent kagi line with
today's price. Using our example, the last kagi line stopped at 133. So
we now compare today's price to 133.
Rule 7. Because the kagi line is
currently rising, if the price advances by any amount, the line is
extended to the new high price.
Rule 8. If the price declines by the
turnaround amount or more (in our
case,four points), then a new line
is drawn down. Based on our example, since the tip of the last line
was 133, the market would have to
fall to at least 129 for a line to be
drawn in the next column.
AnYmoveabove
/Prior highis addedto thisline
135r /
Ii'*
.,,,
U
1 3 5|
l ) (
I n133
| | |
I I I' y
tza lJ
Fromxtoythemarket
mustreversebYthe
turnaroundamount
Rule 9. If the market declines by
less than the predetermined turnaround amount, nothing is drawn.
OUR EXAMPLE: The tip of the last (Baseprice)135I
rss{session
+)
kagi line, from session 4, is at 133.
| ;-1
i
l
l
We compare session5's price of 130
1129(session6)
to this price at L33.Although prices
,r. U
reversed as the market went down
from L33 to 130, the decline was
less than the four points needed to
draw a turnaround line on our kagi
chart. Thus, session 5 is ignored.
The next time a new line is added
is at session 6. At session 5, the
price is at 729 or four points under
the bottom of the prior kagi line at
133. We move to the next column
and draw a turnaround line from
1"33down to 129.
At session 7, the price declines to
127.We extend the line down from
129 to L27 (since the move lower
from 129to 127was in the direction
of the prior kagi line, we do not
need the four-point move that
would be needed for a rising
turnaround line).
129 (Session6)
127 (Session7)
KagiCharts
At session 8, the price has moved
up to 134. This is a seven-point
rally from the low of the prior kagi
line at 127-more than enough to
draw a rising turnaround line.
We then shift to a new column, and
draw a line up from 127 to 134.
Note how this line changed from
narrow to thick once the price exceededthe prior high at 133. This
brings out one of the major features about kagi charts. Specifically:
1Q4(Session8)
-l- 133
I Aboveherelinechanges
fromthin(Yin)to thick(Yang)
127 (Session7)
Line changes from
thin lo thick
when price exceeds
prior shoulder
(i.e.high)
Rule 1,0. If a narrow line in a kagi
chart exceedsthe prior high, at the
point where the previous high was
exceeded,the line becomes thick.
The preceding high is called a
shoulder.
Rule 11. If a thick kagi line breaks
a previous low, the line becomes
nanow at the price where the low
was penetrated.The precedinglow
is called a waist.
IIl
ll'-
Line changes from
thick to thin
when pricefalls under
prior waist (i.e. low)
OUR EXAMPLE: For the rest of this discussion,seeTable 8.1 and Exhibit
8.1.
As described in Rule 11 above, the line changes from thick to thin
when a prior low is broken. Note how in Exhibit 8.L there were times
whentthe market reversed price action, but these reversals weie not
enough to break a preceding to* (for example, from session 19 to 20).
Thus, the line's thickness did not change. However, at session30, the
price at L55 broke under the prior low at 169 (at session 25). Conse-,
quently, when the kagi line for session 30 is drawn, once the price of
that line moves under the prior low of 169, it changes from thick to thin
(from a yang to yin line). Observe how at session38 the market broke a
prior high and, as such, went from a thin yin line to a thick yang line.
Using PercentageKagi Charts
A problem in using a fixed price turnaround amount is that the reversal
amount may have to be adjusted depending on the stock's price. A $1
219
220
The Dispaity lndex and New Price Charts
turnaround may be acceptablefor a $20 or $30 stock, but a $1 turnaround
would be too high for a $5 stock and too low for a $100 stock. The kagi
chart has a unique and powerful approach to this problem-it offers the
ability to use a fixed percentage reversal amount instead of a fixed price.
For example, in a 3o/okagi chart, if the chart starts at $50, the first
turnaround price will be $1.50 (3o/oof $50). If the stock rises to gZ0, the
turnaround price would be $2.10(3o/oof $70). Thus, as the stock's price
rises, the turnaround price would automatically increase, and if the price
falls, the turnaround price would decrease.
Using percentagekagi charts is not as common as the fixed price kagi
in |apan. This is becausemany fapanesetraders prefer to draw the kagi
charts by hand, and doing percentage changes is relatively time consuming. However, with computer software now available for kagi charting
(seethe EQUIS, MetaStocksoftware information at the end of this book),
traders can now easily use percentageturnarounds.
Whether a trader uses a fixed price or a fixed percentage unit as a
reversal, the amount chosen for the turnaround lines is an individual
preference depending on a trader's time frame and trading style. An
expert in kagi from the Nippon Technical Analysts Association passed
on to me that, as a general rule, he uses a 3oloturnaround level for stocks.
The 5olokagi also appearspopular for longer term traders.
TRADING TECHNIQUES WITH THE KAGI CHART
Buy on Yangr Sell on Yin
The are many ways to use kagi charts, but the most basic is to buy when
the kagi line goes from thin to thick, and to sell when the kagi line
changes from thick to thin. Remember that the kagi line becomes thick
(i.e., becomesa yang line) when the prior high is exceeded.The kagi line
converts to a thin yin line when a prior low is broken.
In Exhibit 8.2, I show basic kagi buy and sell signals. The buys occur
with the emergence of a yang (thick) line, and sell signals unfold when
the kagi line converts to a yin line (i.e., thin). As can be seen, when the
market trades sideways, the buy and sell signals can induce losses(for
example, from 82 to 52 and from 83 to s3). This is becausekagi charts,
like renko and three-line break charts, are trending tools, and in nontrending markets can cause traders to frequently move in and out of the
market. (There are ways to circumvent this, for example, by adjusting
the sensitivity. This will be discussed later.) However, the goal of the
kagi chart is to catch longer term trends. This was accomptishedbetween
the buy at Ba and the offsetting sale at Sa. A constructive aspect of this
Kngi Charts
22T.
MERRILLLYNCH- 3% KAGI
100
r00
95
95
90
90
B5
B5
80
BO
7q
75
70
70
55
55
B = BuySignal
S = SellSignal
50
50
JRN TtBI1RR
RPR
IlRY
JUNJULAUO OCI
NOU
MetaStockby EQUIS Int'l
EXHIBIT 8.2. Basic Buy and Sell Signals, Merrill Lynch-3o/o Kagi, Daily
Merrill Lynch chart was that, since january, there was a series of higher
highs and higher lows. This conveyed an underlying strength to the
market. Since Sa,however, there have been lower highs and lower lows.
This aspectof comparing highs and lows is discussedbelow.
Shoulders and Waists
A shoulder is a prior high and a waist is a former low. A seriesof shoulders and waists with ascendinghighs or descendinglows can relay much
information about the underlying tone of the market. As shown in Exhibit
8.3(A), a seriesof rising shoulders (denoted by Sr, 52, dnd 53)and waists
(Wr, Wz, and W3) underscoresthe market's vitality insofar as the bulls
are able to maintain a cycle of higher highs and higher lows. In Exhibit
8.3(B),falling shoulders Sr, Sz,and 53 and declining waists W1, W2, and
W3 echo a market in which the bears have the greater control.
In Exhibit 8.4, we see how a sequenceof higher shoulders (S1-S5)
222
The Disparity Index and New price Charts
wl
W = Waists
S = Shoulder
(A)
RisingShoulders
andRisingWaists
EXHIBIT 8.3.
(B)
FallingShoulders
and FallingWaists
Shoulders and Waists
showed the underlying force of the bulls. The chart also shows how the
waists, at w1-wa, formed ascending lows. while this combination of
higher highs and higher lows was unfolding, the kagi chart reflected a
healthy environment. A hint that the bulls' force was dissipating came
at waist 5 (ws). That waist broke the prior cycle of higher lows since w5
AMERICANCYANAMID#2 KAGI
55
65
50
50
55
55
50
50
'92
lnr
JJ
MetaStockby EQUTSInt'l
EXHIBIT
8.4.
Importance
of Highs
and Lows,
American
Cyanamid-$2
Kagi, Daily
IQgi Charts
223
made a lower low (it was lower than Wa). From a long-term perspective,
this market has shown continuing weakness,as evidencedby the series
of lower major highs at 6-9 and the lower major lows at A-D.
Stock mutual funds prices are based only on the close. Because
candlestickcharts require the open, high, low, and closing prices, they
cannot be used to analyze stock mutual funds. Now, however, we can
technically analyze mutual funds with three-line break, renko and kagi
charts, sincethesetechniquesonly require the close.In Exhibit 8.5 I show
that comparing the heights of the shoulders and waists can be used to
gauge the underlying strength of a mutual fund. In this chart I show a
group of rising shoulders (S1through Sr) and rising waists (W1 to W5).
The first sign of a slackening in demand came when shoulder 56 was
lower that the prior shoulder and waist W5 was lower than the former
waist Wr. After this, area 55 becameresistance.
JANUS FUND - 25 CENT KAGI
20.5
20.5
20.0
20.0
19.5
1 5 .3
19.0
1 90.
tb.3
18.5
1 80.
18.0
'93
EXHIBIT 8.5. Comparing Shoulders and Waists, Janus Fund-.25
'91
Kagi, Daily
224
The Dispaity Index and New Price Charts
Multi-Level Breaks
In Chapter 6, I discussedhow Japanesetraders may wait for extra confirmation in the three-line break chart by waiting for an additional white
or black line. The same strategy can be used with kagi charts. In the kagi
chart, this entails waiting for two or more prior highs or lows to be
penetrated. In Exhibit 8.6., I illustrate how each former high or low is
referred to as a leuel.As illustrated in Exhibit 8.6(A), the thick yang line
converts to a thin yin line when the first level (i.e., the previous waist,
W) is broken. However, some traders may wait for a two-level break,
meaning that the two prior lows at W1 and W2 are broken before a sell
signal is confirmed. Exhibit 8.6,(8)shows a three-levelbreak. This means
that the rally has to exceedthe prior three highs (the prior three shoulders
Sr-Ss)before a buy is confirmed.
As is the case with any technique where extra confirmation requires
extra time, there is less profit potential once the trend is confirmed since
this confirmation takes longer. However, the extra confirmation should
mean greater probability that the trend has changed. We come back to
the immutable law of risk and reward. The less the risk, the less the
reward.
In Exhibit 8.7, a seriesof lower highs (marked sr-ss) and lower lows
(marked Wr-Ws) manifesteda weakening market. However, this cycle of
lower highs and lows was broken with the higher high at 56. Area 55
was also a two-level break since it moved above the prior two highs (at
Saand S5).Further reinforcing the view that this market was bottoming
was that the pullback from 56 stopped above the prior low at w5. This
was the first time in many months that a low (at W6) was higher than
the previous low (at Ws).
Length of Yang and Yin
|ust as the length of a white or black candle line reflectswhether it is the
bulls or bears who are in charge, so it is with a kagi line. By viewing an
Three-Levd
------.Break
Two-Level
One-Level
Break
Two-Level
Break
(A)
Two-Level
Break
EXHIBIT 8.5. Two- and Three-Level Breaks
Break
One-Level
Break
(B)
Three-Level
Break
KngiCharts
225
MCDONALDS3% IGGI
5{
53
51
JJ
52
52
5l
50
5t
50
49
{9
{B
1B
:.1 s2 s3
47
17
16
16
{5
{5
11
wr ,r,
11
{3
{3
12
12
4l
{l
10
{0
s 0 N
J I
N R
bYEQUISInt'l
Metastock
EXHIBIT 8.7. Two-Level Break, McDonald's-37o Kagi, Daily
individuat kagi line and comparing the yin (thin) and yang (thick) sections
of that line, we can obtain insight into who has the balance of powerthe bulls or the bears. Exhibit 8.8 graphically displays this concept of
yang and yin lengths. If the yin and yang sections are the same size,
then it is viewed like a doii, where the market is in balance. If the yang
section is longer, it is the bulls who dominate. A longer yin section means
that the bears are in control.
In Exhibit 8.9, kagi lines L through 3 have longer yang sections than
(a)
v"ngf
.-""
]
#"1
Yang = Yin
Yang Longer
ThanYin
Yin Longer
ThanYang
Neutral
Bullsin Contrd
Bearsin Control
EXHIBIT t.S. ComParing the Length
of the Yin and Yang Sections of a Kagi
Line
226
The Disparity lndex and New Price Charts
19932% KAGI
GOLD_ DECEMBER
110
110
105
100
105
335
390
385
380
395
3S0
385
380
375
375
320
355
350
370
365
360
355
350
355
350
315
315
310
335
310
335
{00
JAN APRJUN
JUL
frtJ0
OCT
NOU
MetaStockby EQUIS Int'l
EXHIBIT 8.9. Yin and Yang Portions of a Kagi Line, Gold-December 1993,2o/o
Kagi, Daily
yin sections.This means that the bulls had a stronger grip on the market
than did the bears. In kagi line 4, the longer height of the yin line as
compared to the yang line kept a bearish undertone to the market.
Where Corrections Stop Within the Prior Kagi Line
Where a correction stops within a kagi line can be used as a gauge of the
market's health. specifically, in kagi charting, the center of a long kagi
line is important. If, as shown in Exhibit 8.10(,{),the market correctsafter
a rally, and this correction stops before touching the center of a prior
long kagi line, it is bullish. Such a scenariodisplays that the bulls kept
the bears from progressing steeply into the bulls' domain. If, in this
scenario,the market then exceedsthe prior shoulder, it is a buy signal
sinceit is a time when the bulls have regained full control of the market.
If, during a downtrend, a rally fails to pierce the midway point of a
Kagi Charts
(A)
SelloffHoldsAbove
Centerof PriorLongLine
r(Linescan be Thickor Thin)
(B)
RallyFailsto Move
EXHIBIT 8'10' The
Abovecenterof priorLongLine
(Linescan be Thickor Thin) Middle of the Kagi Line
prior long kagi line, then it is a negative signal insofar as the butls were
not aggressive enough to push prices above the midway point of the
prior line. This is shown in Exhibit 8.10(8).'once the market declines
past the previous low, it is viewed as a sign to sell since it is at that point
where the bears have wrested control of the market.
Note that it is usually in the longer kagi lines that the midpoint becomes important. This is similar to the middle of long white or black
candles taking on significance.
In Exhibit 8.1"1,I display the middle of some long kagi lines by the
letter M. we see how M1 becamea support area as the low of kagi line
t held above M1. Midpoint M2 had extra importance since M2 wai also
above the prior highs made from March through May in the 109-110
area. The fact that the pullback via kagi line 2 held above these old highs
and also held above Mz relayed the underlying strength of the market.
Area M3 became support on the correction made with the selloff at kagi
line 3. Kagi line 4 broke the support area set up by Mr. Thus far, not
only has the market failed to push above the new resistancearea set up
by Mn, but it has not even managed to push above the lows set by kagi
line 3 (remember the technical axiom that old support can convert to new
resistance).
Double Windows
Double windows can be top or bottom reversalpatterns. (Note: a double
window in kagi charting is different from a window in candle charts.) As
illustrated in Exhibit 8.12(,4),a double window bottom is formed when:
t. during a downtrend, the market bounces and forms a shoulder (at
S). This shoulder's high is less than the prior waist's low (W).
2. the following waist (shown as W2) is also above shoulder 51.
227
The Disparity lndex and New Price Charts
Bonds- December1993,Daity24132l(elgi
120
120
ll5
113
110
110
105
t05
100
100
MetaStockby EQUIS Int'l
EXHIBIT 8.11. Kagi and Halfway Points, Bonds-December 1993,24132ndKagi
DoubleWindow
Bottoms
EXHIBIT 8.12. Double Windows
Double Window
Tops
IGgi Charts
229
This is called a double window becauseboth waists W1 and W2 are above
the intervening shoulder (i.e. S). It is like having a price gap (i.e. an
open window) between the high at shoulder 51 and the lows at waists
to the left and right of this shoulder. If there is more than one shoulder,
it would still be considered a double window if the highest shoulder does
not overlap the waists to the left and right. This is shown in Exhibit
8.12(B).
Double window tops are shown in Exhibits 8.12(C)and 8.12(D).The
double window top is formed when:
1.. during an uptrend the left shoulder (shown by S) is below the following waist (shown by Wj and
2. the next shoulder (at S) is also below W1.
In other words, the shoulders at 51 and 52 that surround the intervening waist (W) are both under W1. Exhibit 8.12(D) illustrates how it
is also a double window top if the lowest waist in a group of waists is
still higher than the two shoulders at 51 and 52.
Exhibit 8.1,3shows how a double window bottom unfolds in a threeCRUDEOIL - JUNE
.1994-
15 CENT KAGI
19.5
1 qq
19.0
19.0
18.5
18.5
18.0
18.0
17.5
17.5
17.0
17.0
1(6
16.5
16.0
15.0
15.5
15.5
15.0
15.0
11.5
11.5
N0u DIC
JfiN
ttB IlAR
APR
11AY
MetaStockby EQUIS Int'l
EXHIBIT 8.13. Double Window Bottom, Crude Oil-fune
1994, 15 Cent Kagi
230
The Dispaity lndex and New PriceCharts
step process.First, we seea low waist at W1. The next step is to compare
the waist (W) to the next shoulder or group of shoulders. In this chart,
a series of shoulders marked 1 through 5 was built during February and
March. Note how waist W1 was above the highest shoulder Sa.Finally,
after the highs of these shoulders are exceeded,we see if the next waist
(W) is higher than the highest shoulder (which was shoulder 4). Since
this criterion was met, we have a double window bottom. In this chart
it is also interesting to see how the support from December through
January became converted to resistance, as evidenced by shoulders 1
through 5. The market breaks this resistancearea, and the double windows are two bullish signals.
In Exhibit 8.14, inlate 1993,we seea double window top. This pattern
was formed since the lowest waist (at 2) was above the surrounding
shouldersat 1 and 3. Another double window top unfolded in early 1994.
For that window we can easily see how shoulder A was below the next
group of waists (at B and C) but it is not as clear that shoulder D is below
B. However, the low at B was 114-6l32ndsand the high at D was
BONDS_ JUNE 1994,24132KAGI
119
118
119
liB
117
116
115
Tfi
113
112
111
110
109
108
107
105
105
101
103
102
101
r17
115
115
111
113
112
111
110
109
108
107
105
105
104
103
102
101
MetaStockby EQUIS Int'l
EXHIBIT 8.14. Double Window Tops, Bonds-|une 1994,24132Kagi
Kagi Charts
231
114-1132nd.
Thus, there was a 5l32nd price gap between the lowest waist
at B and the next shoulder at D. As a result, a double window top was
completed. The ovals that I used to illustrate the two double windows
in this chart are the traditional method used by the japanese to show
double windows.
Trendlines
As shown in Exhibit 8.15, the highs during the decline that began in late
1992 werc defined by a downward sloping resistanceline. of interest
during this decline is that the rebounds (shown by Sl through 55)pushed
up halfway or less into kagi lines 1 through 6. This showed that the
counterattacksby the bulls were relatively feeble. The first sign that the
bulls were starting to get a grip on this market was that the low at Y was
not lower than the low at X. This was the first time in many months that
a lower low was not formed. Areas X and Y formed a double bottom.
AMGEN (3% KAG|-CLS)
75
75
7D
70
b3
65
50
50
55
55
50
50
15
45
10
10
35
35
O
J
R 1 1J
J f l
Metastockby EQUIS Int'l
EXHIBIT
8.15.
Support
and Resistance Lines, Amgen-3o/o
Kagi, Daily
S
232
The Dispaity lndex and NeusPrice Charts
This provided enough of a base for a minor rally. This rally's support
area was a rising trendline that started at Y. Another rising trendline was
formed with the ascending lows from August.
The change of polarity principle can be used (where prior support
becomesresistanceand vice versa) with kagi charts since a prior support
of resistancearea is so evident on a kagi chart. For example, in Exhibit
8.16,we can seehow resistanceareasnear $45and $50becameconverted
to support areas.
Tweezers
As discussedabove, support and resistanceareasoften becomevery clear
on the kagi chart. Exhibit 8.17 shows a double top, or what the Japanese
call a tweezers top. Of interest is that, as annotated on the candle chart
of Wal-Mart, there was also a series of topping patterns based on the
candles.Note how confirmation of the double top on the kagi chart did
UNIONPACIFIC$2 KAGI
55
55
50
50
55
55
Resistance
)U
46
5D
Resistance
+5
+0
+0
A r , |J h S
D
J
tt1
R J f i O l , li
fl
11JNS
MetastockbY EQUIS lnt'l
EXHIBIT 8.16. Change of Polarity Principle, Union Pacific-$2 Kagi, Daily
233
Kagi Charts
Wal-Mart-TWEEZERS
TOp
""'
or+r1r,*1
ifi1*o-eil-tfrLonsUppershadow
32.5
I't'rr[
30.0
??6
nr
"i#l" ftu'l*o"lrrretoror++rp+r1*
JU, U
27.5
'93
27,5
F
08
16 2?
OB 1 5 2 ? 2 9 f t
t2
l9
26
t0
$1 KAGI CHART
??
32
3l
30
29
78
30
?q
28
t(
MetaStockby EQUTSInt't
EXHIBIT 8.17. TweezersTop, Wal_Mart_Candle Chart and
$1 Kagi Chart, Daily
not come until early April, *li"r"u, the candle signals gave earlier
clues
of a topping out Process.This reflectsa limitation of the kagi chart
insofar
as trend reversalsare usually given later in the move. Kigi charts
(like
the three-line break and renko charts) are not for those *ho "r.
trying
pi.t exact tops or bottoms, but who are interested in catchinj
the
19
"meat"
of the move.
Three-Buddha and ReverseThree-Buddha
The basic three-Buddhaand reverse(or inverted) three-Buddha
patterns
are illustrated in Exhibit 8.18. Thesepatterns are the sameas the
Western
head and shoulders and inverted head and shoulders patterns. The
sell
signal is sent when the "right shoulder,, of the three nuaarra
is pierced.
In Exhibit 8.19, I show some ways traders can determine if the
three_
Buddha top can be more bearish or a reversethree-Buddhamore
bullish.
For example, Exhibit 8.19(4) illustrates how the rebound from
the right
Buddha stalled under the center of the prior long kagi line. This
reflected
234
The Dispaity lndex and New Pice Charts
-----
Sell
(A)
BasicThreeBuddhaPattern
------
Buy
(B)
BasicReverseThree
Buddha
EXHIBIT 8.18. Basic Three Buddha and ReverseThree Buddha Patterns
a weak bullish attack. Exhibit 8.19(8) reflects the underlying strength of
the market since the selloff held above the prior long kagi line's midpoint.
Exhibit 8.19(C)and (D) illustrates how three Buddha's can have the extra
importance obtained by a two-level break.
A three-Buddhatop is shown in Exhibit 8.20. The first bearish signal
was given with the break of the uptrend support line. More confirmation
came with the one-level break. For traders who prefer even more bearish
corroboration, the two-level break could have been viewed as extra confirmation of a top.
(A)
Right Buddhafails
under centerof prior line
(B)
RighlBuddhaholds
abovecenterol priorline
(c)
(D)
Two Level Break
of ReverseThree Buddha Pattern
Two Level Break
of Three Buddha Pattern
EXHIBIT 8.19. Variations on Three Buddhas Patterns
Kagi Charts
235
DEC93 CRUDEOIL 3% KAGI
2 10.
21,0
20.5
20.5
20.0
20.0
1S.5
19.5
1 90.
19.0
lB.5
1 85.
i8.0
rB.0
17.5
17,5
1 / .0
1/.0
16.5
15.5
MetaStockby EQUIS Int'l
EXHIBIT 8.20. Three-Buddha Top, December 1993Crude OiL
Exhibit 8.21 displays a classic inverted three-Buddha pattern where
the two waists at Wl and W2 are about the same price. By breaking above
shoulders 51 and 52 (shown at the arrow) the inverted three-Buddha
pattern was confirmed with a two-level break. Note how the old resistance area at shoulders 51 and 52 became support and the market continued to advance with a series of higher waists and higher shoulders.
Record Sessions
A key element used by ]apanese traders in candles and kagi charts is the
concept of record sessions.These are the same record sessionsas discussedin Chapter 3, on candlestickpatterns. In the context of kagi charts,
record sessionsare the counting of the shoulders or the waists. As shown
in Exhibit d.22, a sequenceof nine higher shoulders (not necessarilyconsecutive) is called nine record session highs. Likewise, a group of nine
lower waists is called nine record session lows. The ]apanese view a
market that has about nine record highs or lows as a time to look for a
countertrend move.
236
The Disparity lndex and New Price Charts
DOWJONES(25PTr<AGr)
3950
3950
3900
3900
3850
3800
3750
3200
3550
3500
3550
3500
3150
3100
3350
3850
3800
3250
3200
3650
3600
3550
3500
3450
3100
3350
3300
3250
3200
3150
3300
3250
3200
3150
J
J
A S O N J F 1 A
1
1 J1 R S O N D F
R t 1
MetaStockby EQUIS Int'l
EXHIBIT 8.21. Inverted Three-Buddha,Dow fones-25 Point Kagi
As shown in Exhibit 8.23, inearly 1992,the market formed an inverted
three-Buddha pattern. From there, the bulls took the market from near
$30 to $43. The rally unfolded with nine record session highs. After the
ninth record high, prices stalled, and in early 1993,they formed a double
top near $43.
Although most fapanese traders use Kagi charts built from daily or
9 HigherShoulders= 9 RecordHighs
9 Lower Waists = 9 Record Lows
EXHIBIT 8.22. Record SessionHigh and Lows
Kagi Charts
237
KAGI)
PEPSI(3%
13.0
12.5
42.0
1 15.
1 10.
40.5
10.0
39.5
39.0
38.5
38.0
37.5
3i.0
35.5
13.0
12,5
42.0
11.5
41.0
10.5
10.0
39.5
39.0
38.5
38.0
37.5
32.0
36.5
35.0
35.5
35.0
31.5
Jb. U
35.5
35.0
31.5
31.0
33.5
33.0
32.5
32.0
31.5
31.0
30.5
J-I. U
33.5
33.0
32.5
32.0
<t n
31,0
30.5
'92
JJ
MetaStockbY EQUIS Int'l
EXHIBIT 8.23. Record SessionHighs, Pepsi-3o/oKagi, Daily
weekly closes,kagi charts can be used on an intra-day basisjust as point
and figure charts can be used on a daily or intra-day basis. Exhibit 8.24
shows a five minute kagi chart. This means that the close of each five
minute segment during the day is used to compose the kagi chart. All
the rules to draw the kagi chart and any of the trading techniques previously addressedcan be used on an intra-day kagi chart. In this chart
we see an evident resistance area near 453 in late April and early Muy.
An ascending support line was punctured on May 6th. |ust before the
break of this support line the market reached a new high for the prior
move (at X) and from there a series of nine lower lows emerged. This
formed 9 record sessionlows and increasedthe likelihood of a bounce.
In addition, the lows made on May 9 and L0 formed a double window
bottom.
Exhibit 8.25 shows one of the key advantagesof kagi charts-it allows
a more detailed analysis of markets, such as mutual funds, that have only
closing prices. In this example of the Magellen Fund there various kagi
techniquesthat could have been used to signal a top towards the end of
1993.These signals included:
{53.5
153.0
152.5
152.0
151.5
151
.0
{50.5
150.0
113.5
149.0
.148.5
{48.0
117.5
117.0
416.5
116.0
1{5.5
1{5.0
141.
5
141.0
{{3.5
143.0
412.5
1+2.0
1{1.5
{53.5
{53.0
15?.5
+52.0
151.5
15r.0
150.5
150.0
44q 6
44q n
{{8.5
118.0
++7.5
117.0
416.5
416.0
{15.5
44q n
{4{.5
{41.0
113.5
44? n
44) q
+12.0
1 { .15
EXHIBIT 8.24. Intraday Kagi charts, s & p |une 1994-5 Minute Kagi Chart
MAGELLEN FUND _ DAILY (2OlO
KAGI)
/o
76
75
75
/1
/3
73
7?
72
/1
/l
7D
70
69
69
68
b6
57
67
66
66
55
65
61
6+
63
63
6l
bt
J J
S O N
J S O ND J
MetaStock by EQUIS Int'l
EXHIBIT 8.25. Magellen Fund-2o/o Kagi, Daily
238
PracticeSessionfor the Kagi Chart
1 . The market relayed its underlying strength when price retracements
held above the middle of long kagi lines marked by r, 2 and 3. However, when the bears were aggressiveenough to drag prices under
the middle of long kagi line 3 (at the arrow) it was a clue that the
underlying market condition had changed.
2 . The seriesof ascendinghighs at A through E and rising lows A' to F'
representeda firming market. Warning of a loss of upside drive came
via the lower high at F and the lower low at G'.
3 . From late 1992to late 1993the length of the yang portion of the kagi
lines was longer than the yin portion of those lines. This represented
that the bulls were more in control of the market than were the bears.
But with long kagi line 3 (the same line that broke under the middle
of the prior long kagi line), the longer yin portion of the kagi line,
relative to the yang line, reflecteda time when the bears had grabbed
control of the market.
'Oyama, Kenj| HanawaKurenaiYanagiwa
Midoi, pg. 51.
239
PRACTICE SESSION FOR THE
KAGI CHART
a
a
a
a
a
a
a
a
a
a
a
a
a
a
a
a
a
a
a
a
a
a
a
a
a
O. " photocopy of the graph supplied on page 243or on a piece of
plain paper, create a kagi chart from the data shown in Table 8.2. The
chart's scale should be from a low of $34 to a high of $40. The session
numbers on the right side of Table 8.2 show where the new kagi line is
extended as described in the answer chart (Exhibit 8.26, following the
practice pages). Be sure you try to draw this practice kagi chart on your
own, before looking at the answer chart.
241
242
The Disparity lndex and New Price Charts
TABTE 8.2 Data for Construction of Kagi Chart
Session
't
2
3
4
5
6
7
8
9
10
11
72
13
14
15
16
17
18
19
20
21.
22
23
24
25
26
27
28
29
30
31
32
Date
04t04t94
04105194
MtMt94
04107194
04108194
04171,194
04t12t94
04113194
04t74t94
04t15t94
04t18t94
04119194
04.t20t94
041z'il94
04122194
04125194
Mt26t94
Ml28l94
04t29t94
05t02t94
0s103194
05t04t94
05t05t94
05t06t94
05twt94
05110194
05t11t94
05112194
05113194
45t15t94
05117194
05118194
Close
Session
35.750
37.250
39.000
38.375
37.750
37.750
37.375
35.2s0
35.750
35.250
36.254
35.250
34.500
3s.625
35.500
36.625
36.375
%.250
%.875
37.250
36.875
36.500
37.125
36.375
35.875
36.625
37.125
36.250
37.000
37.250
37.500
38.500
33
34
35
36
37
38
39
40
41,
42
43
M
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
51.
62
63
&
Date
05t19t94
05t20t94
05t23t94
05t24t94
05t25t94
05t26t94
05t27t94
05131,194
06t01,t94
06102t94
06t03i94
06106194
06t07t94
06t08t94
06twt94
06110t94
06t13t94
06114194
06115194
06116194
06t17t94
06t20t94
06t21,t94
06t22t94
06t23t94
06124194
06t27t94
06128194
06t29t94
06lNl94
07t01t94
07105194
Close
39.500
38.875
38.500
39.000
38.500
38.500
39.000
39.000
40.000
39.875
39.875
38.875
38.500
38.250
38.875
39.375
39.375
39.750
39.500
39.375
38.500
37.750
37.625
37.500
36.500
35.000
36.625
36.000
35.875
35.000
35.250
35.125
243
o
Q
tf
t
q
o
)
co
o
@
L
o
@
@
co
o
L
r
ca
f
\
)
f
.a
o
\
t
\
f
o
ca
)
\
o
o
co
t
l
-
.
f
ca
)
c
)
L
f
)
)
L
f
)
t
f
ca
aa
-t
co
a
Y
e
I
I
o
z
J
e
tr.
E\ B\ N
\
#
p
o\
UJ
=---+'
'
@
o
)
@
C:]
rf)
O
tf)
c=
C
+
f
c
o
a
o
-
c
)
a
c=
tf)
C
c
)
@
a
c
@
a
r
c
\
N
a
\
o
O
a
(=
Lf,
o
Lf)
\
c
A
o
L
c
f
n
Lf)
)
c
t
5
a
Lf)
o
)
c
t
a
c
o
EXHIBIT 8.26. Merrill Lynch-1 point Kagi
CONCLUSION
In this book, I have discussedcandlestick charts, the disparity index,
three-linebreaks, and renko and kagi charts. With all of thesetechniques,
the question that may arise is: \Alhich is the best? I cannot say that kagi
charts are better than three-line break or candle charts. They each have
their advantagesand uses. For example,kagi, three-linebreak, and renko
charts are useful for providing a view of the market on a macro scale.
Candlestickcharts can be used on a micro scaleby providing early clues
about market reversals.For example, a member of the Nippon Technical
Analysts Society told me that he uses kagi charts and other japanese
tools, but waits for a candle signal before placing a trade.
In the Introduction to this book, I quoted a samurai who said that,
"Learning is the gate, not the house. You first have to go through the
gate to get to the house." Now, I have taken you through the gate and
up to the door of the house. However, as a ]apanese proverb states,
"Your teachercan lead you to the door; acquiring of learning then rests
on you."
With the help of this book, I hope that you have learned enough to
lay the foundation of basic concepts on which you can build. The techniques I examined should be viewed as basic tools that you can adjust
to your individual trading needs and style. There are so many ways to
use these exciting and powerful tools.
Each trader will find that experimenting with the three-line break,
renki, and kagi charts will depend on individual factors such as trading
style, risk adversity, and trading time frame orientation. There are no
247
248
Conclusion
right or wrong ways to use the new price charts and I am sure many of
you will come up with your own trading ideas.
As one of my contactsin the Nippon TechnicalAnalysts Association
wrote to me: "Al1 my friends use different techniques to confirm their
ideas." The tools discussedin this book are the plants that, when joined
with the fertile soil of your own ideas, should help you reap a rich harvest
of valuable trading concepts.
a a a a a a a a a a a a o a a a a a a a a a a a a a a a a a a a a a a a a a a a a a
GLOSSARY
a a a a a a o o a a a a o a a a a a a o a a a a a a a a a a o a a a o a o a a a a a
J
a
a a
a a
a
a a
a
a
a a
a a
a
a
a
a a
a
a a
a
a a
a
a
a a
a a
a a
a
a a
a
a a
o
a
TECHNICAL TERMS WITH
VISUAL REFERENCES
a
.
a
a
.
a
a
.
This is a glossary of the patterns and the new charting methods discussedin this book. Since I do not discussall the candle patterns in this
book, for those who want a more complete glossary of ine candle patterns, please see my first book, lapaneseCandlestick
ChartingTechniques.
Boldface,Italicized terms are cross-referencedglossary items.
Anchor chart-this was probably the first chart to graphicatly display the
importance of the relationship between the open and ciose. The top
and bottom of the anchor's vertical line are the high and low of that
session.The horizontal line of the anchor line is the open. The arrow
of the anchor line is the close. If the close is higher lh"r, the open,
the arrow points up. If the close is lower than the open the arrow
points down.
Anchor Chart
H
lr qc *Y , J
tl
:t
L
L r
t
r
l
Bar chart-the common chart used in the west. The top and bottom of
the vertical line are the high and low of the session.The horizontal
line on the right of the vertical line is the close and the horizontal line
to the left is the open. The ]apaneseused bar charts before the more
evolved anchor chart and candle chart replaced the bar chart. In es251
252
Glos*ry: TechnicalTermsasithVisualReferences
sence the bar chart is a less evolved form of charting than the candle
chart. See also anchor chart, pole chart, and stopping chart
BarChart(High-Low-Close)
:rFf',tf
Basepice-the starting price in a kagi chart, renko chart, and three'line
chart.
Beaish engulfingpattern-a bearish candle pattern in which during a rally
there is a black real body that envelopes the prior white real body.
The larger the second candle in relation to the first candle, the more
effective the pattern should be. A bearish engulfing pattern should
act as resistance.
BearishEngulfingPattern
,ol
Black shoes-see "buy when the neck emergesfrom the white suit with
black shoes" and " sell if the black shoe comes out of a black suit
aftu a neck"
Black suit-see " sell if the black shoe comes out of a black suit after a
neck"
Blackturnnroundline-the black line in a three-line break chart that breaks
the low of the prior three consecutive white lines. See also white
firnaround line.
BlackTurnaround
Une
Whenthis is
brokendraw
a black lurnaround
line
Glossary: TechnicalTermswith VisualReferences E3
Blendedcandle-a single candle line built by combining two or more candle
lines of a candle pattern. The blended candle can be used to help
determine whether a group of candle lines is bullish or bearish. To
construct the blended candle:
L. The oPen of the blended candle is the open of the first sessionof
the candle pattern.
2. The top of the upper shadow of the blended candle is the highest
high of the candle pattern (i.e., the top of the highest Jpper
shadow).
3. The low of the blended candle's lower shadow is the lowest low
of all the sessionsof that pattern (i.e., the bottom of the lowest
lower shadow).
4. The closeof the blended candle is the close of the candle pattern,s
last session.
BlendedCandle
,tnn of the pattern
/
.il.["---;
o?--------
------------U
-------r
\'-,";;";";"(A)
_
Candlepatlern
(B)
Blendedcandle
Bullishengulfingpattern-abottom reversalsignal that is composedof two
candle lines, the first is black and the secondis white. The white real
of- this pattern wraps around, or engulfs, the prior black real
P.{y
body. The second real body of this pattern (that is the white candle)
should be much larger than the first (i.e., black) real body. A bullish
engulfing pattern should act as support.
BullishEngulfing
Pattern
l t l
ril
"Buy when
the neckemerges
from the uthitesuit with blackshoes,,-aylexpression used by Japanesetechniciansto describea bullish three-line6reak
chart pattern. A short black line is sometimescalled a black shoe, a
254
Glossary: TechnicalTermswith VisualReferences
white turnaround line (a white line that surpassesthe prior three black
lines) is sometimeslikened to a white suit and a small white line that
follows a zahite turnaround line is called a neck since it looks like a
neck coming out the white suit.
"BuyWhentheNeckEmerges
fromtheWhiteSuitwithBlackShoes',
Neck
(Buy Signal)
White
Suit
Candlestick
chart (also called candlechart)-the most popular method of
charting by the Japanese.used since the 19th century, a candlestick
chart uses the same data as a bar chart (the open, high, row,
and
close). However, the candle chart gives more'graphic information
about the market's health by segmenting individiral candle lines into
the real body and shadows.
CandleStickChart (High-Low-Close-Open)
t:l
"i
"I ' t I
tl
A
Changeof polarity-a term used to describethe technical principle by which
old resistanceshould be converted to new r.tppori and old support
should be transformed to new resistance.
Changeof Polarity
Glossary: TechnicalTermswith VisualReferences ?55
Collapsingdoji star-a top reversal signal made up of three lines. The first
is a tall white candle after which the market gaps lower via a falling
doii. The third candle of this pattern is a black real body sessionthat
gaps under the doji's session. The three candles that make up this
pattern are the same three as those needed for an evening doji star
(SeeezteningStar). The differenceis that the evening doji star has the
doji above the tall white real body while the collapsing doji star has
the doji gapping under, instead of above, the first white candle.
CollapsingDogi Star
,,ufl
Dark cloud coaer-during an uptrend there is a tall white candle followed
by a sessionthat opens at a new high. But by the end of that session
the market closesas a black candle with a close well inside the prior
long white candle's real body. The classicdark cloud cover's second
sessionshould close under the midpoint of the prior white candle.
As a general rule, the deeper the close of the dark cloud cover's
second session pushes into the white candle, the more bearish the
signal. In the stock market, it could still be viewed as a dark cloud
cover if the second session'sopen is above the prior session'sclose
Dark GloudCover
,ilf
256
Glossary: TechnicalTermswith Visual References
(instead of the prior session'shigh). Dark cloud covers should also
be resistance.
Deaduoss-a bearish indication formed when a short-term moving averagecrossesunder a long-term moving average.Seealsogolden cross.
DeadCross
Dead
Cross
-----
ShorttermMovingAverage
LongtermMovingAverage
Dispaity index or disparity ratio-an oscillator that compares the close of
the current sessionto a moving averageon a percentagebasis. For
example, a 25-day disparity index of -10o/omeans that today's price
is 1,0olo
under the 25-day moving average. Some of the ways the disparity index can be used include: as an overbought/oversoldindicator,
as a signal of trend direction, and as a tool to gauge divergence.See
also dioergence index.
DisparityIndex
+15
+10
+5
-----------------
0
-5
-10
-15
Diaergenceindex*a percentage oscillator calculated by taking the current
price and dividing it by the chosen moving average. Thus, a 25-day
divergence of 110o/owould mean that the close today is L100/oof the
25-day moving average. The divergence is the same as the ilisparity
Glossary:Technical
Terms
with VisualReferencesE7
index, it is just scaled differently. That is, a 25-day divergence index
reading of 110o/ois the same as a 25-day disparity index of +10olo.
Divergence Index
115
110
105
100
95
90
85
Doji-a session in which the open and close are the same. It reflects
indecision and is a clue that the force behind the prior trend may be
dwindling, especially if the doji comes after a tall white real body or
after an extended move. Doji can also be used as a resistancearea.
Doii
High
I l,*,n
Open and \
Close
J
Doublewindows-a pattern in kagi charts. Double windows can be top or
bottom reversal patterns. A double window bottom is constructed
when the market forms a left waist (shown as Wr) that is above the
next shoulder (shown as 51) and the following waist (shown by Wr)
is also above shoulder Sr. A double window top is completed when,
during an uptrend, the left shoulder (shown by S) is below the folDoubleWndows
DoubleWindowBottom
Double Window Top
258
Glossary: TechnicalTermswith VisualReferences
lowing waist (shown by wt) and the next shoulder (at s) is alsobelow
waist W1.
Engulfing patterns-See bearish engulfing pattern, bullish engulfing pattern, Iast engulfing bottom, and last engulfing top
Eaening star-a top reversal pattern made of three candle lines. The criteria for this pattern include an up-trending market in which a long
white candle is followed by a small real body (which can be black or
white) that should not touch the real body of the first candle. The
third candle of this pattern is a black real body that does not touch
the real body of the second candle and then closeswell into the white
candle line that made up the first candle of this pattern. If the second
candle of the evening star is a doii instead of a small real body then
the pattern is an evening doji star.
EveningStar
Canbe whiieor black.
if this is a Doii
patternis an
EveningO0,.,\
,
, l
fl ,ll rI f
Gappingdoji*a doTi session that gaps lower during a declining market.
GappingDoii
<-
* '
Window
I
Glossary:Technical
Terms
with VisualRefurenca ?59
Goldencross-the fapanese term for when a short-term
moving average
crossesabove a long-term moving average. see also dead
cfoss.
GoldenCross
Dead
Cross
-----
ShorttermMovingAverage
LongtermMovingAverage
Hammer-a bullish candle line. The hammer has four
criteria:
1. the prior trend must be down
2. a small real body (black or white) that is near the
upper end of the
trading range
3. a long lower shadow usually three times or more the
length of the
real body
4. little or no upper shadow
The hanging man and hammer have the same shape.
\A/hat differen_
tiates one from the other is that the hammer foll,ows
a downtrend
while the hanging man is after an uptrend.
Hanging man-abearish candle line with confirmation
of the next session.
The hanging man has five criteria:
1. the prior trend must be up
Hanging Man
-./
ql ,
Black
wWhrte
ll'-[F{Wtr;
;t
I
Hammer
n
1,"./,
I
ru
260
Glossary: TechnicalTermswith VisualReferences
2. a small real body (black or white) that is near the upper end of the
trading range
3. a long lower shadow usually three times or more the length of the
real body and
4. little or no upper shadow
5. bearish confirmation of the next session with a close under the
hanging man's real body.
The hanging man andhammer look the same. However, the hammer
comes after a downtrend and the hanging man emerges after an uptrend.
Harami-this dual line candle pattern has an unusually long real body
(white or black) followed by a very small real body (black or white)
that holds within the first candle's real body. The classicharami should
have the second session's real body in the middle of the first real
body. Seealso harami cross, high price harami, and low price harami.
Harami
Harami
Cross
f+f+
Harami cross-rt the second candle of.a harami is a doji instead of a small
real body, the pattern is called a harami cross.
HighPrice
Harami
High price harami-a harami in which the second real body of the harami
is near the upper end of the first real body. Seealso lout price harami,
High-wauecandle-a candle line with usually long upper and lower shadoars. The high-wave candle's long lower shadow shows buyers enter
(or sellers retreat) as the market moves lower, but the long upper
shadow indicates a rejection of higher price levels. A high wave candle
shows the trend has shifted into a neutral posture since it reflects a
market that is in a state of confusion.
High-Wave
Candles
I
+
I
Real body can be blackor white
Glossary: TechnicalTermswith VisualReferences
Inflectionline-the short horizontal line in a kagi chart.
InflectionLine
lnflection
linesat
1,2, and3
KagiChart
IGgi chart-One of the three types of fapanesecharts (seealso renko and
three-line break charts) that does not have time on the horizontal axis.
The basic premise of the kagi chart is that the thickness and the direction of the kagi lines are dependent on the market's action. If the
market continues to move in the direction of the prior kagi line, that
line is extended. However, if the market reversesby a predetermined
amount, a new kagi line is drawn in the next column in the opposite
direction. When prices penetrate a prior low or high, the thickness of
the kagi line changes. The kagi chart can be constructed using percentage or fixed amount reversals. See also inflection line, yang line,
and yin line.
51
51
53
53
3t
5?
5l
il
50
50
19
19
18
18
17
47
16
16
15
15
11
11
13
{3
1?
17
{t
1l
{0
10
S O N
J I
N A
261
262
Glossary: TechnicalTermswith VisualReferences
Lastengulfingbottom-thisa bullish candlepattern that has the samegroup
of candle lines that form the bearish engulfing pattern (a large black
candle that engulfs the prior white candle). However, the bearish
engulfing pattern appears after a rising market while the last engulfing
pattern appears after a falling market. see also last engurfing top.
LastEngulfingBottom
"rI
Lastengulfing top-this bearish candle pattern has the same configuration
as the bullish engulfingpattern (a large white candle that envelops a
small black real body). However, the last engulfing top appearsafter
an uptrend, whereas the bullish engulfing pattern appears during a
price decline. See also last engulfing bottom.
Last EngulfingTop
I
,' il
Long blackcandle-a candle line with an extended black real body. This
means that the closeis near the session'slow and the open was near
the high. A long black candle should have its real body at least three
times larger than surrounding real bodies. Long black candlescan be
used as a tool to confirm a resistancearea,as a confirmation of a break
of support and the long black real body can be used as a resistance
area.The resistanceset up by a long black candle should be from 50o/o
within the candle up to the top of the candle (including the upper
shadow). See also long white candle.
Long BlackCandle
J. I
I
r f
Long
Black
candle
Glossary: TechnicalTermswith VisualReferences
263
Longwhite candle-a candle with a tall white real body in which the open
of the session is near the low, and the close is near the high. The
length of the real body should be at least three times the length of
recent real bodies. Some of the uses of long white real bodies include
helping to confirm support and reinforcing the importance of a breakout from a resistancearea. The long white candle can also be used as
a support area. The support should be from midway of the white
candle down to the bottom of the white candle (this includes the
bottom of the lower shadow). See also long black candle.
LongWhite Candle
il
il ilil
white
Lono
[-cadre
Low priceharami-a harami in which the second real body of the pattern
is near the bottom end of the first real body. See also high price harami.
Low Price Harami
|lt l
l l l
U ?
Eithercandlecan be black or white
Morning star-a bottom reversal pattern composed of three candle lines.
During a downtrend there is a black real body. This is the first part
of the pattern. The second session is a small real body candle that
does not touch the first (i.e. black) real body. The second real body
can be white or black. The last session of the morning star is a long
white real body that ideally should not touch the second real body.
This long white real body should close well into the first candle's
black real body to complete this pattern. If the second candle of this
pattern is a doji instead of a small real body then this pattern becomes
a morning doji star.
Neck-see "buy zahen the neck emerges from the uthite suit with black
shoes" and "sell if the black shoe comes out of a black suit after a
neck'
New Price Charts-used to describe a chart in which a new price, high or
low, has to be reached before another line can be placed on the chart.
MorningStar
264
Glossary: TechnicalTermswith VisualReferences
Japanesenew price charts include the kagi chart, renko chart, and
three-line break chart.
Piercingpattern-This is a two candle pattern that emerges after a downtrend. The first part of this pattern is a long black real body. In the
next sessionthe market opens at a new low for the move, but by the
close of the sessionthe market forms a white candle that closes50o/o
or more into the prior black real body.
Piercing Pattern
CloseAboveBlack
CandlesCenter
Polecharts-a chart constructed of the high and low of each session. It
was the second type of chart used by the fapanese. see also anchor
charts, bar charts, candle charts, and stopping charts.
PoleCharts(High-Low)
ReaIbody-the rectangular portion of the candlestick line. The top and
bottom of the real body represent the open and close of the session.
If the sessions'closeis under the open, the real body is filled in, with
Real Body
*{il.--:
l.-
Glossary: TechnicalTermswith Visual References
the top of the real body the open and the bottom of the real body the
close. If the session'sclose is above the open, then the real body is
empty with the top of the real body at the close and the bottom at
the open. The size and color of the real body give important clues
about the health of the market. See also candlestick charts, longblack
real bodies, long uthite real bodies, and spinning tops.
Recordsessions-in fapan, a new high or a new low is referred to as a
record session. In candle theory, a market that reaches eight to ten
consecutive (or almost consecutive) record session highs or record
session lows is a time when the market is overextended.
RecordSessions
10 RecordHighs
10
9
I
7
s
3
l ,
2
6 l
l l
i l r l
'l lr
Low
0 RecordLows
High
I
I
I
jr Itr
3
4
il'
7
I
I
10
Renkochart-one of the three kinds of ]apanese charts (see also kagi and
three-line break charts\ that does not take time into account for constructing the chart. Each line in a renko chart is called a brick. Rising
bricks are shown as white and falling bricks are shown as black. A
new white (black) brick is added when a rally (seltoff) continues in
the same direction once a fixed amount has been exceeded. In renko
charts, the portion of the rally or selloff that does not exceedthe fixed
265
266
Glosscry;Technical
Termswith VisualReferences
amount is not shown. In renko charts, each renko brick is the same
size.
RenkoChart
1'>)
t?2
121
r20
119
118
117
116
115
ll4
113
112
111
110
109
121
120
119
118
n7
115
llf,
lt+
113
112
111
110
109
108
107
106
r08
107
106
105
101
103
102
r05
101
103
102
"Sell if the black
shoecomesout of a blacksuit after n neck"-an expression
used in japan to denote a bearish three-line chart pattern. A short
black line is sometimescalled a black shoe, a black turnaround line (a
black line that surpassesthe prior three white lines) is sometimes
called a black suit, and a small white line is sometimescalled a neck,
since it looks like a neck coming out the white suit.
'Sell if the Black Shoe Comes
Out of a Black Suit After a Neck"
Neck
Glossary: TechnicalTermswith VisualReferences 267
Shadows-Thelines above and below the real body. The top of the uPPer
shadow is the high of the sessionand the bottom of the lower shadow
is the low of the session.Long uPper shadows reflect that the market
rejected higher prices. Long lower shadows show that the selling
pressure evaporated (or the bears were overwhelmed by the bulls) at
lower prices. see also candlestick chart and high Toauecandle.
Shadows
High
Low
Shootingstar-a bearish candle line with its long upper shadow candle
with a small real body (black or white) that is near the bottom end of
the trading range. Since the shooting star is a top reversal signal, it
should appear after an uptrend.
ShootingStar
Black or
I
l-l-u761s
tl
Shoulders-a prior high in kagi charting.
Shoulders
S1 to So Are Shoulders.
268
Glossary: TechnicalTermswith VisualReferences
Spinning top-a candle line with a small real body. It is a sign that the
prior move may be losing its momentum.
Spinning
Tops
il
Real body can be
black or white.
sping-a bullish signal where the market breaks under an important
support areaand then "springs" back above the broken support area.
See also upthrust.
Spring
Stoppingchart-a chart that uses only closing prices. It was the first type
of chart used by the ]apanese.Seealso anchor chart, bar chart, canille
chart, and pole chart.
StoppingChart
&
rt-
Three-Iine
break-one of the three types of Japanesecharts (seealso renko
and kagi charts) that does not consider time. In other words there is
no time scaleon the horizontal axis. Rising lines are shown as white
and falling lines as black. when starting to draw a graph, the first
line is a rising white line if it rises, or the first line is a black falling
line if it declines.Then, if the price exceedsthe first line, a new white
line is drawn in the next column. If instead, the next price was below
the first line, then a black line is drawn in the next column. A new
line is only drawn when a new high or new low is touched. To determine if the market has started down, the low price of the last three
rising lines must be broken on the downside during the fall. on the
other hand, to determine if a decline has ended, the highest price of
Glossary: TechnicalTermswith VisualReferences
the last three declining lines must be exceededon the upside. See
also black and white turnaround lines.
Three-Line
Break
8.0
8,0
7,5
7 q
7,0
7,0
Lower yields = Higher Prices.
8uy signals given with black
turnaround lines.
5.5
Higher yields = Lower Prices.
Sell signals given with
white turnaround lines
5.5
5.0
5,0
'9 2
' 93
Trend-since most of the candle signals are reversals, there must be a
prior trend to reversefor a candle pattern or candle line to have meaning. For instance a doji in the middle of a trading zone would not be
an important trading signal sincethere is no trend to reverse.Another
instance where trend is important is the hammer and hanging man
lines. Both of these lines look the same, but one is a bullish nu*-".
if it comesafter a downtrend, and the other is a hanging man if comes
after an uptrend.
Turnaroundline-See black turnaround tine and white turnaround line.
Trttoblackgappingcandles-two black real body candles that follow a
falling
windout.
Two BlackGappingCandles
I
'l
Falling
Window
t__________
nz
269
270
Glossary: TechnicalTermswith VisualReferences
Upthrust-a bearish signal insofar as the market breaksthrough important
resistance,but then fails to hold the new highs and pulls back under
the previously pierced resistancearea. See also spring.
Upthrust
Resistance
Waists-a prior low in kagi charting.
Waists
W1 to Wa are Waists
White suit-see "buy zohenthe neck emergesfrom the uthite suit with black
shoes" and "sell if the black shoe come out of a brack suit after a
neck'
Whiteturnaroundline-the white line in a three-linebreak
chartthat exceeds
the high of the prior three consecutive black lines. See also btack
turnaround line.
WhiteTurnaround
Line
Whenthis €
is exceeded
drawa white
turnaround
line
windows-a continuation pattern in candle charts. A window is the same
as a gap in western technicals.There are rising and falling windows.
A rising window is a bullish continuation pattern that is formed when
the top of yesterday's upper shadow is under the low of the current
lower shadow. A falling window opens when the prior session,slow
Glossary: TechnicalTermswith VisualReferences 27r
(i.e., the bottom of the lower shadow) is above the top of the current
upper shadow.
Windows
Upper Shadowof (1)
does not Touch Lower
Shadow of (2)
RisingWindow
It
Lower Shadowof (1)
does not Touch Upper
Shadow of (2)
Close UnderTop
of Window Keeps
Downtrend in Force
I
\
I
* \ r
WindowActs
as Resistance
(1
a;t
' l , ;Fr
l ' l
I
FallingWindow
I
Yang line-in kagi charts, another name for the thick portion of the kagi
line. See also yin line
Yang Line
Yin line-in kagi charts, another name for the thin segment of the kagi
line. See alsoyang line.
Yin Line
INDEX
a
a
a
a
a
a
a
a
a
a
a
a
a
a
.
.
a
a
a
a
a
a
a
A
Abandoned baby, morning star
and, 117-118
Accumulation, real body and,
42-45
Aggression:
hammers and, 57
windows and, 1(X
American Cyanamid,222
Amex,34
Amgen, 32, 58, 125,132
Analysis of StockPice in lapan
(NTAA), 156,n3
Anchor charts:
candle chart compared, 3Z-38
candle chart evolution and, 17
Apple, 96,778
AST,92
Aurora Electric, 22
B
Balanceof power, in stock
markets, 153
Bank America, 24
Bar charts, 8
candle chart compared, 3-4, 35
candle chart evolution, 17
Baruch, Bemard, 15
Baseprice:
kagi charts, 276-279
renko chart, 200-203
three-line break chart, 168-720
Black real body, described, 18, 19.
SeealsoLong black real bodies;
Real bodv
Black shoe, t-hreeline break
charts, trading techniques
with, 184-185
a
a
a
a
a
a
a
a
o
a
a
a
Black suits, threeJine break
charts, trading techniques
with, 184-186
Black turnaround line, threeline
break charts, 173
Blended candle:
dark cloud cover, 58-69
described, 35-37
morning star and, 121
Bond markets. SeealsoFufures
markets; Stock markets
candle charts and, 9
hanging man and, 62
harami, 93
kagi charts, 228,2n
last engulfing pattern, 86
long white rcal bodies, 27, 28
renko charts, 2M,205
shooting stars, 66
stops,131
three-line break charts and. 180
trendlines, !10
Bricks, renko chart, 197
Bristol Myers, 35
Buy signals:
kagi charts, 220-227
renko charts, 203-2U
three-line break charts
neck, 184-185
trading techniques with, lZ4776
threeJine break charts and, 181782
c
Candle charts:
bar charts compared, 3-4
evolution of, 15-18
anchor chart, 17
a
a
a
a
a
a
a
a
a
.
bar chart, 17
candle chart, L8
pole chart, 17
stopping chaft,76-77
history of, 13-15
overview of,7-77
technical picture and, 129-150.
SeealsoTechnical picture
three-line break charts and,
trading techniques with,
176-178
threeJine break charts
compared, 153
vetsatility of, 8
Candle lines:
construction of, 18-19
dual candle lines, 68-93. Seealso
Dual candle lines
single candle lines, 56-68. See
alsoSingle candle lines
three or more candle lines, 109727. Seea/soThree or more
candle lines
Change, technical picture and,
742-74
Change of polarity principle:
hanging man and, 53
shooting star and, 55
Charts, utility of, 3
Chronology, candle charts and, 19
Citicorp, 25
ClassicWestem theory. See
Western theory
Closing prices:
candle charts and, L9
harami and, 91
kagi charts, 215
long white real bodies, 20
prior real body compared, 38-40
275
276
lndex
Closing (Continued)
renko chart construction, 199203
three-line break charts and. 158774,180
windows and,94-95
Coca Cola,79
Cocoa, 99, 136
Collapsing doji star, evening star
and, 114-115
Color, of real body, 35-38
Computer:
candle pattern location, 1M-1,45
criteria specification, 745-147
offset trade, 148-749
hade placing, 147-148
Confucius, 129
Congestion band, dark cloud
cover and,72
Contrarian opinion, fapanese
history and, 14-15
Correction stop location, kagi
charts, 226-227
Crude oil:
candle charts, 36
hanging man and, 51, 62
high-wave candles, 54
kagi charts, 229,235
price adjustments, 143, 1.M
record sessions,126
spinning tops, 43
windows and, 103
D
Daimyo (feudal lords), 13
Dark cloud cover:
described, 58-72
harami and, 91
prevalence of, 75
stops, 130-132
windows and,97,703
Data vendor services,described,
79
Daxro, 101
Dead cross, moving averages,
757-158
Dell, 50, 80
Delta, 106, 767,187
Demand. SeeSupply-demand
situation
DeutscheMark, 52, 65,87,83,764
Directional pattern analysis,
candle chart analysis, 37, 38
Disjointed candles. SeeWindows
Disney,67,115,758
Disparity index, 153, 759-154
generally, 159
trading with, 159-164
Distribution, real body and, 42-45
Divergence, disparity index, 1.59164
Divergence index, described, 764156
Doii, 20
collapsing doji star, evening star
and, 114-115
described, 45-50
engulfing patterns and, 82, 83
gapping, windows and, 106-109
gapping doji, evening star and,
115
gravestone doji, record sessions,
724-125
harami and, 88, 91.
morning star and, 1.1.7
shadows and, 51, 53
threeline break charts and, 180
windows and.96-97
Double top:
kagi charts, 232-233
threeJine break charts, trading
techniques with, 188, 189
Double windows, kagi charts,
227-231.SeealsoWindows
Dow Chemical, 89
Dow jones, 27,42,236
Dual candle lines, 58-93
dark cloud cover.58-72
engulfing patterns, 75-83
harami, 85-93
last engulfing patterns, 84-86
piercing pattetn, 73-76
E
Eastman Kodak, 71, 85
Emotion:
futures market and, 14
markets and, L5-15
piercing pattern and, 75
Engulfing pattern:
described, 75-83
evening star and, 111
windows and,96
EQUIS International, 11
Equity International Magazine,
190n1
Euroweek (magazine), 4, 5n2
Evening doji star pattern, 48
Evening star, described,,7W-716
F
Falling windows. Seealso
Windows
meaning of, 93,94, 100-101
morning star and, 118-119
Feudalism, fapan, 13
Fibonacciretracements, L49
Five-year notes, 139
Fixed price kagi charts, percentage
kagi charts and,220
Flexibility, evening star and, 111772
Ford,776,182
Foreign exchangemarket, candle
charts and, 9
The Fountainof Gold-The Three
Monkey Recordof Money
(Homma), 74-1,6,710
Frequency, of real body, 35-38
Futures markets. SeealsoBond.
markets; Stock markets
candle chart history and, 13
candle charts and, 9
emotion and, 14
engulfing patterns and, 81
fapanesehistory and, 13-14
prior real body, opening
compared to, 38-39
trends,138
G
Gap,82
windows and, 93. Seealso
Windows
Gapping doji:
evening star and, 115
windows and, 106-109
Gas oil, 87
General Motors, 720, 121.,178, 179
General Re, 23, 90
German Bund, 61
German Mark. SeeDeutsche Mark
Gold:
emotion and, 15, 15
hammer and, 59
kagi charts, 226
renko charts, 205
stops, 131
windows and, 104
Golden cross, moving averages,
157-158
Gravestone doji:
described, 48, 49
record sessions,724-125
H
Hammer, 52
described, 55-59
hanging man and, 51
harami and, 90
piercing pattern and,, 76
shooting star contrasted, 66-68
three-line break charts and. 178
windows and, 95
Hanging man:
described, 59-54
piercing pattern and., 76
Index
shooting star contrasted, 6f-68
three-line break charts and, 778,
779-lffi
Harami:
described, 86-93
three-line break charts and, 779180
windows and, 97, 102-103
Head and shoulders, threeBuddha pattern, stops, 132133
Heinz, 111
High price area, long black real
bodies, 29-30
High-price harami, described, 88
High-wave candles:
morning star and, L17
shadows and, 52-54
shooting star and, 55
windows and, 102
Home Depot,29,30
Homma, Munehisa, 74-16, 722
Hoshii, Kazutaka, 5n1, L65n1
Hudson Bay Trading Company, 9
I
IBM, 100, 109
In and out trading, renko charts,
204
Inflection line, kagi charts, 213,
217
Intel, 204
International Paper, 141
Inverted three-Buddha, kagi
charts, 233-235
Iraqi War (79n), 75, 15
Ishii, Katsuto shi, 165n2
I
]anus Fund, 223
fapan:
candle charts and, 4
candle charts history, 73-16
stock market of,78,213
lapan Economiclournal, 5
lapaneseCandlestickCharting
Techniques
(Nison), 7, 8
|apaneseYen, 55
|CPenney, 117
|ohnson and fohnson, 107
K
Kagi charts, 9, 753, 213-245
candle charts compared, 153
construction of , 275-220
first line, 215
generally, 215
percentage charts, 279-220
second line,216-217
third line, 278-219
overview of,213-2'1,4
practice session for, 247-245
sensitivity of , 754
trading techniques, 220-239
buy and sell signals (Yang and
Ylu:.\,220-221
correction stop location, 225227
double windows, 227-237
multi-level breaks, 224
record sessions,235-239
shoulders and waists, 227-223
three-Buddha and reverse
three-Buddha, 233-235
trend lines, 237-232
tweezers, 232-233
yang and yin length, 224-226
Key charts. SeeKagi charts
Kyoho Era,77
L
Last engulfing patterns, described,
u-fJ6
LeBeau, Charles, 138
Lilco,777
Line chart. SeeStopping chart
Lin Yutang, 8
Long black real bodies, 29-34. See
alsoReal body
doji and, 47-48
at high price area, 29-30
as resistance,33-U
resistanceconfirmation. 30-31
size, frequency, and color, 35-38
support breaking, 31-32
two, windows and, 105-106
Long white real bodies, 20-29. See
alsoReal body
defined, 20
doji and, 45-46,47,51
low price level, 27
resistance breaking, 23-24
size, frequency, and color, 35-38
as support, 25-29
support confirmation, 27-23
windows and,,96-97
Lower shadow, described, 19
Low-price harami, described, 88
Low price level, long white real
bodies, 21
Lucas, David, 138
Markets, emotion and, 15-76. See
a/soBond markets; Futures
markets; Stock markets
Market trends. SeeTrends
McDonald's, 225
MegellenFund,237,238
Meiji period, 14, 18
Menill Lynch,221
Metastock software, 11
Mexico Telephone, 124, 786
Mideast War (1990),15, 15
Mobil, 190
Momentum, doji and, 49-50
Morning star:
described, 116, 777-121
windows and, 102
Moving averages/157-766
disparity index, 159-164
divergence index, 164-766
golden and dead cross, 157-158
long black real bodies, 30, 31-32
long white real bodies, 27, 22
overview of,757
Moving shadow, hammers and,
57-58
Multi-level breaks, kagi charts, 224
Murphy, John, 8
Mutual funds, kagi charts, 223
N
Natural gas,49
Neck, threeline break charts,
trading techniques with, 184186
Neri chart. SeeRenko chart
Newton, Isaac, 15
Nikkei, 83, 725, 765-166
Nippon Technical Analysts
Association, 19, 120, 129, 153,
766n3, 1l]6, 787, 220, 248
Notionnel Bond, 51, 108
o
Offset trade, computer, 78-149
Opening price:
candle charts and, 19
harami and, 91
long white real bodies, 20
prior real body compared, 38-40
Overbought/oversold indicator,
disparity index, 159-164
Oyama, Kenji, 155n1.,239n1
P
M
Manville, 39, r()
Mark. SeeDeutsche Mark
Market prediction, candle charts
and, 18
277
Pacific Telephone, L88
Patterns, 55-727
dual candle lines, 58-93
dark cloud cover,68-72
engulfing patterns, 76-83
278
Index
Patterns(Continued)
harami, 85-93
last engulfing patterns, 84-86
piercing pattern, 73-76
overview of, 55-56
single candle lines, 56-68
generally, 56
hammer, 56-59
hanging man, 59-64
shooting star,64-68
three or more candle lines, 109127
evening star, 109-116
morning star, 117-121
record sessions, 121.-127
windows, 9S-109
Pepsi, 237
Percentagekagi charts:
fixed price kagi charts and,220
use of, 219-220
Pfizer, 112, 189
Piercing pattern:
described,,73-76
record sessions, 125-127
Point and figure charts, 7, 8, 153,
213
Point chart. SeeStopping chart
Polarity principle, kagi charts, 232
Pole chart, candle chart evolution,
17
Price, value compared, 14
Prior real body, opening
compared to, 38-40
Psychology:
computer and, 145
of markets, 14
patterns and, 55
shadows,50
R
Rallies:
dark cloud cover and,72
shooting stars,67
threeline break charts, 157
Rate of change (ROC) oscillator,
doii and, 49, 50
Reactions,windows and, 94
Real body, 20-50
accumulation and distribution.
42-45
described,18,19,20
doji and, 45-50
engulfing patterns and, 76-77,
81-82,83
harami and, 85-88, 90-91
long black real bodies, 29-34
at high price area, 29-30
as resistance,33-34
resistanceconfirmation, 30-31
support breaking, 31-32
long white real bodies, 20-29
defined, 20
low price level, 21
resistancebr eaking, 23-24
as support, 25-29
support confirmation, 21-23
prior real body, opening
compared to, 38-40
size, frequency, and color of,
35-38
spinning tops, 40-42
Recordsessions:
kagi charts, 235-239
three-line break charts, trading
techniqueswith, 186-187
three or more candle lines, L21127
Relative strength index, long black
real bodies. 29. 30
Renko charts, 9, 153, 197-210
candle charts compared, 153
construction of, 199-203
first brick, 200-202
generally, 199-200
second brick, 202-203
subsequentbricks, 203
overview of,197-198
practice session fior, 207-210
sensitivity of,154
trading techniques with, 203-205
Resistance:
dark cloud cover and,70,72
doji as, 46,47-48
engulfing patterns and, 78,
79-80,81,82
evening star and, 111,,112
hammers and, 57-58
hanging man and, 61.,62, 63
harami and,91,92
kagi charts, 223, 231-232
long black real bodies, 30-31
long black real bodies as, 33-34
long white real bodies, 23-24
piercing pattern and, 76
stops, 130
three-line break charts, trading
techniques with, 187-188
windows and, 94, 97, 98-99
Retracementlevel:
long black real bodies, 34
long white real bodies, 21
Reversalsignal:
candle chart/bar chart compared,
a
candle charts, 154-155
engulfing patterns and, 79
renko charts, 203
three-line break charts, 184-185
Reversethree-Buddha,kagi
charts, 233-235
Reward. SeeRisk/reward
Rice futures:
candle chart history and, 13-1.4,
17
kagi chart, 153
Rising gap, dark cloud cover and,
71
Rising windows. Seea/soWindows
meaningof, 93,94, 95,96, 103,
104
stops,130-132
Risk/reward:
candle charts and, 9
engulfing patterns and, 80
hammers and,57
technical picture, 733-137
Rubbermaid,41
Rumor, markets and, 15
S
Sakata,Goho, 127n1,150n1-4
Sakatacharts. SeeCandle charts
Sekigahara,Battle of, 13
Selloffs:
engulfing patterns and, 79-80,
81
harami and, 90
renko charts, 204
threeline break charts. 157
windows and,96
Sell signals:
kagi charts, 220-227
renko charts, 203-204
three-line break charts, 174-176,
181-182
Shadows:
dark cloud cover and, 68-69
described,79,50-52
engulfing patterns and, 77
hammersand, 57-58
hanging man and, 59-64
harami and,90-97,92
high-wave candles and, 52-54
shooting stars,64-68
three-line break charts and, 180
windows and,93,96
Shooting star:
dark cloud cover and. 7L
described. 64-58
harami and, 89-90
windows and,97,98
Shoulders:
kagi charts, 219, 221-223,229230,235
Index
three-Buddha pattern, stops,
132-133
Silver:
piercing pattern and, 75
spinning tops, 44
windows and, 98
Single candle lines, 56-68
generally, 56
hammer, 55-59
hanging man, 59-64
shooting star,64-68
windows and, 98
Size, of real body, 35-38
Small real bodies. SeeSpinning
tops
Southwest Bell. 70
s & P , 5 3 , 7 9 , 1 3 4 ,! 6 3 , 2 3 8
Spinning tops, 20
described. 40-42
doji and, 48
hammers and, 57, 58, 59
shooting stars and, 64, 66
Star chart. SeeStopping chart
Stock markets. SeealsoBond
markets; Futures markets
balance of power in, 153
candle charts and, 9, 19
dark cloud cover,68-72
doji lines, 45-50
engulfing patterns, 76-83
evening star, 109-116
hammers. 56-59
hanging man and, 59-64
kagi charts, 213-245.Seealso
Kagi charts
last engulfing pattern, 84-86
long black real bodies, 29-34
long body size, frequency, and
color, 35-38
long white real bodies, 21-29
morning star, 117-121.
moving averages/157-765.See
alsoMoving averages
opening and closing prices,
L9
piercing pattern, 73-76
prior real body, opening
compared to, 38-40
record sessions.three or more
candle lines, 121-127
renko charts, 197-210.Seealso
Renko charts
shadows. 50-54
shooting stars,64-68
spinning tops,40-42
technical picture, 129-150.See
alsoTechnical picture
three-line break charts, 167-195.
SeealsoThree-line break
charts
windows and, 93-109
Stopping chart, candle chart
evolution, 16-17
Stops:
described, 130-133
risk/reward, 133-137
Subiectivity, morning star and,
119,120
Supply-demand situation:
candle chart/bar chart comPared,
3
candle chart history and, 14
patterns and, 55
spinning tops, 43
Support:
hammers and, 57-58
hanging man and, 63
kagi charts, 231.-232
long black real bodies, 31-32
long white real bodies, 21-23,
25-29
stops,130
windows and, 94, 96,97
T
Tall white candle. SeeLong white
real bodies
Technical analysis, candle charts
and, 18
Technical picture, 129-150
change and,142-1M
computer and, 1M-149
candle pattern location, 1t14745
criteria specification, 1'45-1'47
offset trade, 1'48-1'49
trade placing, 1'47-1'48
overview of,129-130
risk/reward, 133-137
stops,130-133
trend,137-142
TechnicalTradersGuide to Computer
Analysisof the FuturesMarket
(LeBeau and Lucas), L38
TechTalk (TV show), 8
Tendline, long white real bodies,
21
Three-Buddha Pattern:
kagi charts, 233-235
stops,132-133
Three-line break charts, 9, 153,
167-195
candle charts comPared, 153
279
construction of , 168-174
base price, 168-169
first line, 170
second line, 170-\71
third line, 171-172
three consecutive white or
black lines, 172-174
overview of,1,67-168
practice session for, 791-195
renko chart compared, 197
sensitivity of , 154
trading techniques wlth, 174-190
black shoe, white and black
suits, and a neck, 184-186
buy and sell signals, 174-776
candle charts and, 776-178
record sessionsand, 186-187
trend reversal, 182-784
trends and, \78-181
variations oI,181-182
Western patterns and, 187190
Three or more candle lines, 109127
evening star, 109-116
morning star, 116, 117-721
record sessions,721,-\27
Three windows, described, 102105
Time and timing:
kagi charts, 224
three-line break charts and, 181182
Tokugawa, Ieyasu, 13
Tokugawa Shogunate, 13
Trendline:
kagi charts, 231-232
long black real bodies, 31
long white real bodies, 2L
three-line break charts, trading
techniques with, 188
trend determination by, 138
Trends:
candle chart/bar chart compared,
J
disparity index, 159-164
technical picture, 137-"142
threeline break charts, 782-1U
threeline break charts and.,178181
Turnaround amount:
kagi chart construction,215,216,
217
percentagekagi charts, 219-220
Tweezerstop:
kagi charts, 232-233
threeline break charts, trading
techniques with, 188, 189
280
lndex
Two-paired chimney:
kagi charts, 232-233
threeline break charts, trading
techniques with, 188, 189
U
Union Pacific,165,232
Unleaded gas, 102
Upjohn, 33
Upper shadow, described, 19
Upthrust:
hammers and,57
shooting stars and, 64, 56
Uptrend support line, three-line
break charts, hading
techniques with, 187-188
v
Value, price compared, 14
Vendors. SeeDatavendor sewices
Volatility, renko charts, 204
Volume, windows and, 96
w
Waists,kagi charts, 219,227-223,
229-230,235
The Wall Streetlournal, 61,
Wal-Mart, 135,232,233
WasteManagement,113
Westerntheory:.
candlescompared,36
engulfing patterns and, 79
hanging man and, 53
threeline break charts, trading
techniques with, 187-190
trends, 137-738
Whipsaws, three-line break charts,
trend reversal, 184
Whispering tactics, markets and,
15
White real body, described, 18, 19.
SeealsoLong white real bodies
White suits, three-line break
charts, trading techniques
with, 184-186
White turnaround line, three-line
break charts, 173, 779, 180,
181,183, l8/.,190
Windows, 93-109. SeealsoFalling
windows; Rising windows
black gapping candles, two,
105*105
described, generally, 93-102
double windows, kagi charts,
227-231
falling window, morning star
and, 118-119
gapping doji and, 106-109
rising window, stops, 130-132
three windows. 102-105
World Bank, 7, 60-61
Y
Yang line, kagi charts, 277,224226. SeealsoYin and Yang
Yasui, Taichi, 5n3
Yen. SeeJapaneseYen
Yin and Yang:
kagi charts and, 213, 220-22'1,,
224-226
markets and, 15-16, 110
Yin line, kagi charts, 2L7